'.—(1) In section 437 of the Taxes Act 1988 (extent to which payments in respect of new annuities are to be treated as charges on income), for subsections (1A) and (1B) there shall be substituted the following subsection—
(1A) In the computation, otherwise than in accordance with the provisions applicable to Case I of Schedule D, of the profits for any accounting period of a company's life assurance business, new annuities paid by the company in that period shall be brought into account by treating an amount equal to the income limit for that period as a sum disbursed as expenses of management of the company for that period.
(2) In subsection (1C) of that section (interpretation of section), after "this section" there shall be inserted "(but subject to subsections (1CA) to (1CD) below)"; and after that subsection there shall be inserted the following subsections—
(1CA) Where a new annuity ('the actual annuity') is a steep-reduction annuity, the income limit for an accounting period of the company paying the annuity shall be computed for the purposes of this section as if—
- (a)the contract providing for the actual annuity provided instead for the annuities identified by subsections (1CB) and (ICC) below; and
- (b)the consideration for each of those annuities were to be determined by the making of a just and reasonable apportionment of the consideration for the actual annuity.
(ICB) The annuities mentioned in subsection (1CA)(a) above are—
- (a)an annuity the payments in respect of which are confined to the payments in respect of the actual annuity that fall to be made before the earliest time for the making in respect of the actual annuity of a reduced payment such as is mentioned in section 437A(1)(c); and
- (b)subject to subsection (1CC) below, an annuity the payments in respect of which are all the payments in respect of the actual annuity other than those mentioned in paragraph (a) above.
(1CC) Where an annuity identified by paragraph (b) of subsection (1CB) above ('the later annuity') would itself be a steep—reduction annuity, the annuities mentioned in subsection (1CA)(a) above—
- (a) shall not include the later annuity; but
- (b) shall include, instead, the annuities which would be identified by subsection (1CB) above (with as many further applications of this subsection as may be necessary for securing that none of the annuities mentioned in subsection (1CA)(a) above is a steep—reduction annuity) if references in that subsection to the actual annuity were references to the later annuity.
(1CD) Subsections (1CA) to (1CC) above shall be construed in accordance with section 437A.
(3) After that section there shall be inserted the following section—
"Meaning of 'steep-reduction annuity' etc
437A.—(1) For the purposes of section 437 an annuity is a steep—reduction annuity if—
- (a)the amount of any payment in respect of the annuity (but not the term of the annuity) depends on any contingency other than the duration of a human life or lives;
- (b)the annuitant is entitled in respect of the annuity to payments of different amounts at different times; and
- those payments include a payment ('a reduced payment') of an amount which is substantially smaller than the amount of at least one of the earlier payments in respect of that annuity to which the annuitant is entitled.
(2) Where there are different intervals between payments to which an annuitant is entitled in respect of any annuity, the question whether or not the conditions in subsection (1)(b) and(c) above are satisfied in the case of that annuity shall be determined by assuming—
- (a)that the annuitant's entitlement, after the first payment, to payments in respect of that annuity is an entitlement to payments at yearly intervals on the anniversary of the first payment; and
- (b)that the amount to which the annuitant is assumed to be entitled on each such anniversary is equal to the annuitant's assumed entitlement for the year ending with that anniversary.
(3) For the purposes of subsection (2) above an annuitant's assumed entitlement for any year shall be determined as follows—
- (a)the annuitant's entitlement to each payment in respect of the annuity shall be taken to accrue at a constant rate during the interval between the previous payment and that payment; and
- (b)his assumed entitlement for any year shall be taken to be equal to the aggregate of the amounts which, in accordance with paragraph (a) above, are treated as accruing in that year.
(4) In the case of an annuity to which subsection (2) above applies, the reference in section 437(1CB)(a) to the making of a reduced payment shall be construed as if it were a reference to the making of a payment in respect of that annuity which (applying subsection (3)(a) above) is taken to accrue at a rate that is substantially less than the rate at which at least one of the earlier payments in respect of that annuity is taken to accrue.154
- (a) any question arises for the purposes of this section whether the amount of any payment in respect of any annuity—
- (i) is substantially smaller than the amount of, or
- (ii) accrues at a rate substantially less than, an earlier payment in respect of that annuity, and
- (b) the annuitant or, as the case may be, every annuitant is an individual who is beneficially entitled to all the rights conferred on him as such an annuitant,
that question shall be determined without regard to so much of the difference between the amounts or rates as is referable to a reduction falling to be made as a result of the occurrence of a death.
(6) Where the amount of any one or more of the payments to which an annuitant is entitled in respect of an annuity depends on any contingency, his entitlement to payments in respect of that annuity shall be determined for the purposes of section 437(1CA) to (1CC) and this section according to whatever (applying any relevant actuarial principles) is the most likely outcome in relation to that contingency.
(7) Where any agreement or arrangement has effect for varying the rights of an annuitant in relation to a payment in respect of any annuity, that payment shall be taken, for the purposes of section 437(1CA) to (1CC) and this section, to be a payment of the amount to which the annuitant is entitled in accordance with that agreement or arrangement.
(8) References in this section to a contingency include references to a contingency that consists wholly or partly in the exercise by any person of any option.
(4) Section 434B(2) of that Act (treatment of annuities paid by an insurance company) shall cease to have effect and accordingly—
- (a)in section 76(2A)(b) of that Act (limit on expenses of management of insurance companies), the word "and" shall be inserted at the end of sub-paragraph (ii), and sub-paragraph (iv) (together with the word "and" immediately preceding it) shall be omitted; and
- (b)in section 337(2B) of that Act, for "the references in sections 338(2) and 434B(2)" there shall be substituted "the reference in section 338(2)".
(5) In paragraph 9B of Schedule 19AC to that Act (subsection (3) inserted in section 434B in relation to overseas life insurance companies), for the words from the beginning to "An" there shall be substituted—
9B. The following section shall be treated as inserted after section 434A—
Treatment of annuities 434AA. An".
(6) In sub-paragraph (l) of paragraph 16 of Schedule 7 to the Finance Act 1991 (which makes transitional provision for annuities under contracts made in accounting periods beginning before 1st January 1992), for the words before paragraph (a) there shall be substituted—
(1) In the computation, otherwise than in accordance with the provisions applicable to Case I of Schedule D, of the profits for any accounting period of an insurance company's life assurance business, an amount equal to the lesser of the following amounts shall be treated (if it is not nil) as a sum disbursed as expenses of management of the company for that period, that is to say—".
(7) Subsections (1) and (4) to (6) above have effect in relation to accounting periods beginning after 5th March 1997.
(8) Subsections (2) and (3) above have effect in relation to accounting periods ending on or after 5th March 1997 but do not affect the computation of the capital elements contained in any annuity payments made before that date.'.—[Mr. Jack.]
§ Brought up, and read the First time.155
§ 4 pm
§ The Financial Secretary to the Treasury (Mr. Michael Jack)
I beg to move, That the clause be read a Second time.
§ Mr. Jack
It is important to give the House some reasons why the new clause has appeared at a relatively late stage. That happened simply because it was only literally in the past few weeks that the Inland Revenue discovered what was going on. Tax avoiders cannot expect some sort of close season during the passage of a Finance Bill when, having discovered their tricks, we will not act to stop them.
A sharp-eyed inspector of taxes worked out that something funny was going on after investigating parts of a banks tax affairs at which the company would not have expected him to look, and thereby discovered the basis of the new clause. His action clearly demonstrated the benefit of our "spend to save" initiative.
The trick that lies at the heart of the matter involves the bank buying a series of annuities from a life insurance company that are in theory to last for the life of bank employees in their 20s, but the pattern of payments is structured so that the capital paid is returned with interest within five years and after that a trivial amount is paid to keep the annuity going.
The tax rules on annuities have the result that nearly all the payment is classed as income, because annuities on the lives of younger people are deemed to consist mostly of income. If the person holding an oddly structured annuity of that sort were an individual, the effect of the rules would be to charge him to tax on far more income than was justified, so an individual annuitant would not take out such an annuity.
When a bank holds the annuity, because of the way in which it is taxed as a trader, it makes no difference to it what part of the annuity is treated under the tax rules as income, as the rules do not affect banks; but the insurance company gets relief for all the payments treated by the rules as income when in commercial reality they are a return of capital.
The new clause proposes that, when an annuity contract involves a substantial reduction in the amount of an annuity payment at any time, the annuity is treated for the tax purposes of the life insurance company as if it were two separate annuities, one short term with high payments and one long term with low payments. That will ensure that the life company gets relief for the income return inherent in the contract, but no more.
The new clause applies to payments made on or after 5 March 1997, when we announced the new measures. We thought long and hard before confining the measure to future payments. The House is rightly wary of retrospective legislation imposing a charge to tax on payments that have already been made, and we felt it right that in, for example, the leasing clauses, we applied the new rules only to payments made after Budget day; but, if companies continue to abuse the tax system in such blatant ways, I cannot say that we would never introduce 156 retrospective legislation in appropriate cases. This case is on the borderline, and I have given it the benefit of the doubt, but the message to tax avoiders is: beware.
§ Mr. Alan Milburn (Darlington)
I am grateful to the Minister for that explanation and for providing an earlier briefing on the matter. I add my congratulations to his sharp-eyed inspector of taxes on spotting the abuse.
As I understand it, the new clause is in essence intended to prevent an abuse which has recently developed whereby a life insurance company gets favourable tax treatment by using a financial trading company, such as a bank, as the recipient of front-end loaded annuity payments. The tax position of the financial trader, the bank, means that it is taxed only on the difference between the amount paid for the annuities and the amount received from them, rather than on the total income.
The insurance company gains by making large early payments on an annuity to reduce its overall tax liability. It treats the payments as income, even though they are in effect capital, as they involve the payment of the bulk of the value of the annuity. That is, in essence, the nature of the abuse. Both the bank and the insurance company gain from the device and the only loser is the Exchequer or the taxpayer.
Although new clause 8 seems to be a sensible measure, I have several questions. Can the Minister say how many companies are taking advantage of the arrangement? Am I right in thinking that one particular insurance company has been at the forefront of this avoidance scam? What does he estimate the losses to the Exchequer to have been? What is the potential loss? [Interruption.]
§ Madam Speaker
Order. More electronic devices. There is a ruling about that. Will the hon. Member for Sheffield, Attercliffe (Mr. Betts) remove both himself and the device until it has stopped?
§ Mr. Milburn
We seem to be having a problem with electronic devices.
What will the introduction of new clause 8 mean in terms of protection for the Exchequer? I have a question about the means that the Government have chosen to close off the abuse. It is being stopped, as I understand it, by two means—most notably, by deeming annuity payments to be management expenses of insurance companies rather than charges, as, historically and economically, they have always been regarded. Insurance companies have more flexibility in respect of what they can do with surplus charges than with excess management expenses. For example, where there are surplus charges in an insurance company's purchase annuity business, the loss can be surrendered against profits in another part of the group. Although I cannot think of an example off the top of my head of an innocent insurance company that could be adversely affected by new clause 8, theoretically there could be. What consideration did the Minister give to targeting the abuse more precisely rather than changing the overall basis on which annuities rank for tax relief in insurance companies?
We must take particular care in dealing with insurance, because the Minister knows as well as I do that the insurance industry is a key part of the UK's financial services sector, which contributes about 18 per cent. of our gross domestic product and employs hundreds of 157 thousands of people. It is an important sector of the economy, and has been successful in recent years, both domestically and internationally. When we take action that affects the sector, wherever possible we must ensure that we are helping, rather than hindering, the industry's efforts. I seek assurances on that point.
I also seek an assurance that new clause 8 will have no repercussions for the many members of the public who take out ordinary annuities. I appreciate that the device that new clause 8 seeks to close down is not one that ordinary individuals use, but it is important that the Minister takes the opportunity of giving an absolute assurance to people taking out ordinary annuities that they will not be affected. Ordinary policyholders should not suffer as a result of misbehaviour in an isolated part of the corporate sector.
In essence, we welcome the measure and the prior briefings that the Minister was able to afford us on the matter. I simply seek reassurances on the points that I raised.
§ Mr. Jack
I am grateful to the hon. Member for Darlington (Mr. Milburn) for the way in which he supported new clause 8. His support for the sharp-eyed revenue inspector will be warmly welcomed; I add mine.
The hon. Gentleman asked about the number of companies that we have identified. So far, one example has been found and the action proposed in new clause 8 will save up to £100 million in tax loss alone. We estimate that the tax loss at this moment probably amounts to about £20 million; but, if we had not taken action, some £1.5 billion in tax might have been at risk.
§ Mr. Milburn
The Minister says that one company was taking advantage of this tax avoidance scam. Does he know whether the industry at large was contemplating following that company's initiative?
§ Mr. Jack
In the course of investigating one company's set of books, the Inland Revenue discovered the problem. Obviously, the Revenue will look at other examples if they come to light; in any case, we acted quickly, and the new clause should be a deterrent to others that might seek to follow suit. I cannot guarantee that no other such attempts were in the pipeline at the time of the first discovery, but as we moved swiftly—within weeks of the discovery—to close the loophole, I hope that we have ring-fenced this anti-avoidance measure.
The hon. Gentleman went on to ask about the mechanisms involved in ensuring that the new clause will put a stop to this sort of tax avoidance. It is important to distinguish between the ring fencing, as a result of this work, of the losses in this area of life assurance, to prevent them from being used elsewhere in a company, and another more specific element. I hope that the hon. Gentleman has a copy of the notes on clauses—if he does not, I apologise. Paragraph 31 shows that the object of the proposal—to divide the annuity arrangement into two and effectively to increase the amount in repayment, to capital as opposed to income—is subtly to remove the beneficial effects of this type of activity in respect of the I minus E calculation. That calculation is at the heart of the way life assurance companies are taxed on their annuity business. How the avoidance is rendered unattractive is described in some detail in the notes on clauses.
158 The hon. Gentleman asked whether the innocent, at company or individual level, are protected. I can assure him that companies that are not seeking to contrive such arrangements will not, to the best of our knowledge, be affected. One of the difficulties of this sort of anti-avoidance work is that we cannot be certain how many people have attempted avoidance. In this case, we were lucky enough to have had a sharp-eyed inspector who spotted the problem, and we hope that the new clause will be a shot across the bows of anyone contemplating a variation on the theme. Nevertheless, I cannot guarantee that some who may look innocent but are actually up to their tricks will be caught by the measure. Still, the new clause, and the Opposition's strong support for it, will send out a powerful message.
The hon. Gentleman asked, finally, whether ordinary individuals with annuities will be affected in any way. The answer is no.
§ Question put and agreed to.
§ Clause read a Second time, and added to the Bill.