Insurance Premium Tax (Hansard, 27 January 1998)

§ Mr. Alasdair Morgan (Galloway and Upper Nithsdale)
Thank you, Mr. Deputy Speaker, for the opportunity to raise this important issue.
Insurance premium tax was first introduced in the Finance Act 1994, and is payable on insurance premiums in the United Kingdom. The Finance Act 1997 made a number of changes to IPT—they were claimed at the time to be anti-avoidance measures—which introduced a higher rate of 17.5 per cent. for a range of insurance services where insurance was provided in conjunction with other goods or services.
The introduction of that higher rate was described by the last Administration as a measure to counter alleged VAT avoidance in the form of "value shifting" on a limited range of insurances sold with goods and services. Tax avoidance was allegedly taking place through the inflation of the value of the insurance element, which was charged at the old IPT rate of 2.5 per cent. rather than being liable to VAT at 17.5 per cent. The three main areas affected by the new higher rate were insurance relating to motor vehicles, insurance relating to domestic appliances and travel insurance.
Compelling legal evidence suggests that the higher-rate IPT, as currently constituted, is in breach of European law. I should stress that I have no sympathy for the tax dodgers who provoked the over-reaction of an increase in the rate. I hope that the Financial Secretary to the Treasury will acknowledge that, as many of the arguments that I shall advance were deployed by her when she was an Opposition spokesperson during the Committee stage of last year's Finance Bill. On 6 February 1997, she spoke at some length about the introduction of higher-rate IPT. She asked:
Why have the Government taken a broad-brush approach that is likely to catch innocent commercial interests? Is the Financial Secretary still concerned about the fact that innocents have been hit by what she herself described as a broad-brush approach? I hope to show that many of the "innocent commercial interests" to which she referred in her speech last year have been hit. Higher-rate IPT has had a significant impact on the travel industry—the industry which the Financial Secretary herself suggested last year was least guilty, and which to my mind is largely innocent, of the so-called value shifting. Will the Financial Secretary tell us what she has discovered over the past year that persuades her that value shifting has occurred in respect of travel insurance? Will she comment on the following points?
I understand that, because the travel service is either zero rated or part of the tour operators' margin scheme whereby a profit margin is calculated and subject to VAT according to specific regulations, value shifting is, in effect, not possible. When no VAT is due on travel services, where does the value shifting, or tax loss, arise? As the Financial Secretary said last year:
Customs receives VAT on the margin on the holiday from the tour operator—on the full selling value of the holiday—irrespective of the discount given by the travel agent … It is difficult to see how value shifting could take place if the full value of VAT, at 17.5 per cent., was paid on the holiday irrespective of the discount. 255 What is the Financial Secretary's view on that now, given that last year she described the examples used by the previous Government to justify the imposition of higher rate IPT on the travel industry as
not a description of value shifting in the travel industry, but of over-priced insurance"? That analysis has also been justified by the recent Monopolies and Mergers Commission report on package holidays, which suggested that heavy discounts for holidays and the low cost of package deals was to do with the highly competitive nature of the travel sector, and nothing to do with a surreptitious attempt at value shifting. Is the Minister aware of those MMC findings? I suggest that they blow a hole in the Government's argument.
In the run-up to this evening's debate, I spoke to a number of ordinary travel agents and travel operators, who were clear about the impact of the policy on their business. With respect to travel insurance, the introduction of IPT has resulted in a distortion of the market. Over the past few years, travel agents have been steadily losing market share in this area. Since the introduction of higher rate IPT, that decline has trebled. Last year alone, there was a 33 per cent. fall in market share for travel agents.
Not all that lost business, however, is going to competitors. A significant number of people are now simply not taking out travel insurance. It has been reliably assessed that before the introduction of IPT, about one in 25 holiday-makers travelled abroad without travel insurance. Now that figure is nearer to one in 10. That information comes from a survey of holiday-makers and is compelling evidence of an IPT-related problem that the Minister herself raised last year.
The present Financial Secretary said:
I am worried that in trying to raise revenue from an ill-targeted piece of legislation towards the travel agents, the Government may lose money elsewhere. There is a danger that people may start travelling abroad without adequate insurance cover … At present, it costs British consuls £200 million a year to underwrite drivers who get into difficulty while on holiday and who are not adequately insured. If more tourists slip through the insurance net, that is likely to affect the budget of the Foreign and Commonwealth Office, which will have to bail out uninsured tourists. The Minister will also be aware that travel agencies, particularly small independents, operate with tiny profit margins of between 1 and 2 per cent. Holiday insurance was always one of the most profitable elements of their business. That insurance business has now been cut by about a third in the past year alone, with a devastating impact on general profitability.
I have received representations from travel agents who point out that the only reason that their businesses survived this year was the increased spending on holidays as a result of the windfall payments from building society share issues. That factor will not be in place next year, and they predict confidently but without any pleasure that many small travel agents will go to the wall.
Clearly, the impact does not fall solely on the travel sector. In terms of lost contracts, bankruptcies and job losses, the clearest indications so far have come from electrical retailers.
256 During the Committee stage of the Finance Bill last year, the Tory Government insisted that there was clear evidence of value shifting from the rental sector, among others. The present Financial Secretary queried that assertion. She said: A television or video's rental cost comprises two parts: the rental of the appliance and a maintenance charge. The charge is usually split, and it is explained to the customer that the total charge is made up of two parts. The Minister read out a letter written in … 1994, which showed that the companies reversed the rental and insurance proportions. He said that that was value shifting … The companies' argument is that first, in 1992, they successfully won a VAT tribunal on the issue. Following that tribunal, they reassessed their business. The cost of buying appliances such as videos or televisions is becoming relatively cheaper because of competition and technology, and so, therefore, is rental. But the cost of labour … has increased and it is included in the insurance part of the rental charge. The companies would regard that as a legitimate business reassessment, and the Minister made the point for them in last year's debate.
The strength of that argument has been confirmed by another Monopolies and Mergers Commission report on the supply of domestic electrical goods. The findings debunk the Government's claims of tax avoidance in both the rental and sales sectors. The MMC's findings have been accepted in their entirety by the President of the Board of Trade.
The MMC report claimed that the price of electrical goods was being kept artificially high and that real costs had fallen dramatically. Therefore, the decision of the rental companies to keep the commodity rental element of their packages low is in line with what the MMC said should be the position.
With regard to sale warranties, the Government's argument, in contrast, for the introduction of higher rate IPT was that transfer pricing was taking place from lowly priced but high-taxed goods to high-priced but low-taxed warranties. They were stating that retail prices for electrical goods were being kept artificially low, in direct contrast to the MMC and the Department of Trade and Industry, which now state that they are being kept artificially high.
The MMC further found that there was little price difference between suppliers selling their own warranties and those who were not, so what evidence is there for price shifting? What justification is there for higher rate IPT on this sector in the light of the MMC report? I suggest that there is none. While IPT remains in place, businesses are suffering enormous losses and jobs are once again being lost.
Thorn and Granada were the examples given by the Financial Secretary last year. Between them, they have lost in the region of £20 million in business and around 800 jobs across the country. They are subject to aggressive marketing from direct insurers, who point out the tax disadvantage of purchasing a warranty through either of those companies. Their market share has fallen.
The Government cannot have it both ways. Electrical retailers cannot be guilty of both price shifting and artificially raising prices. Has the Financial Secretary spoken to the DTI about the MMC's findings? Surely that report invalidates the Government's justification for higher rate IPT.
The Minister will also be aware of the impact of IPT on motor vehicle traders. The discriminatory tax applies to maintenance insurance, which has all the accompanying 257 benefits of statutory regulation and policing that go with any insurance policy, while vendors' warranties are not taxed and have no backup should the vendor go out of business. There is now a trend towards the use of less-reliably backed but tax-free warranties, with the result that more and more costs are being borne by vehicle purchasers when they find that they are without adequate cover. The consumer is losing out as a result of the tax.
If the Minister remains unmoved by the personal and business impact of the higher rate IPT, perhaps the Government's mind will be focused by some of the legal arguments that strongly suggest that the current structure of IPT is in breach of European law in a number of areas. I am grateful to Messrs. Waelbroeck and Malherbe, who are European tax law experts, for their advice in this complex area. I believe the Minister has had an opportunity to review their opinion.
On reading the Waelbroeck report, hon. Members will see that higher rate IPT offends European law in relation to VAT, competition law and the freedom to provide services. I urge the Minister to review the full detail of that report on these points.
There are some solutions to these problems. My first suggestion to the Minister would be a meeting between herself and key figures in the industries affected. This morning, I met some senior representatives of a number of leading companies and trade bodies. I will be happy bring a delegation of representatives, not just from the travel sector but from all the sectors affected, to meet her.
My second suggestion concerns extra-statutory concessions. I believe that such concessions have already been agreed with a small number of insurers. Will the Minister consider extending these concessions at least to cover groups where there is no evidence of value shifting? If not, will she explain why concessions are being offered in what appears to be a fairly makeshift manner?
Ideally, this matter should be resolved through primary legislation, not piecemeal concessions. In that regard, my third suggestion to the Minister would be a general tax avoidance measure in the forthcoming Budget. All along the Government have assured us that higher rate IPT was designed to catch the tax cheats. I have made it clear in my speech that the method chosen has had a wider effect in terms of distortion of the market, and a direct effect on ordinary people, through redundancies and closures.
Tax avoidance measures can be introduced without these unpalatable side effects. I urge the Minister to follow that route rather than continuing to penalise a limited number of sectors through IPT.
My final suggestion to the Minister is the most important, and again it is one that she suggested last year. She asked: Why did the Government choose to tackle the problem with a two-rate IPT? Why did they not use other routes, such as a flat-rate"?—[0fficial Report, Standing Committee B, 6 February 1997; c. 177–82.] At that time, the Minister argued for an increased flat rate. She should—and indeed must—introduce a level playing field in the insurance market.
Higher rate insurance premium tax is a tax gone wrong. I hope that the Government will take note of my representations and return to a flat, non-punitive rate of insurance premium tax for all sections of the insurance industry. How can it be right that a customer can go into 258 a travel agent, a television rental shop or a garage and be offered insurance at 17.5 per cent. tax and then go next door to an insurance broker and get the same cover at 4 per cent. tax?
Higher rate IPT is a barrier to fair competition; it causes hardship and job losses and I urge the Minister to act now.

§ The Financial Secretary to the Treasury (Dawn Primarolo)
I congratulate the hon. Member for Galloway and Upper Nithsdale (Mr. Morgan) on his speech, particularly the excellent parts where he quoted me. Never has an Adjournment debate included so many excellent quotations from a Minister when in opposition, so I congratulate myself on that.
The hon. Gentleman raised a number of important points. As his speech demonstrated—when he repeated my words back to me—I fully understand and appreciate the concerns that he expressed. In addressing those concerns, I should like to explain the Government's approach to the issue, on which there is a continuing debate.
First, the central issue is tax avoidance, on which the hon. Gentleman expressed his view clearly. The term tax avoidance does not necessarily imply that the gaining of a tax advantage was the prime motive for the way in which the travel industry, for example, chose to arrange its business, although that is undoubtedly the case in some respects. There may well be commercial, non-tax reasons for the emphasis on insurance sales. However, the Government have the right to address the adverse effect of those trading arrangements. The higher rate of insurance premium tax does just that. It does not prevent any trader from undertaking what may be a common commercial practice. It simply removes the tax incentive and ensures that the Exchequer does not suffer.
Secondly, the common practice by travel agents of offering discounted holidays conditional on the sale of their own travel insurance is often cited as a reason for applying the higher rate of IPT to the travel industry. That is not so. Discounting of holidays has no effect on the tax take, as tour operators account for the tax on the undiscounted price of the holiday.
As in the other sectors affected, the issue behind the introduction of the higher rate is simply one of disproportionate margins. Even the travel industry accepts that the margins earned from insurance sales are far higher than those from the sale of the holiday. Typically, a travel agent will earn 10 per cent. on a holiday and 50 per cent. plus on the insurance. Even before the introduction of the tax measure, one would normally pay considerably more for travel insurance purchased from a travel agent than one would for that bought from a specialist travel insurance broker. The Government's concern in respect of IPT is the adverse effect on the Revenue.

§ Mr. Alasdair Morgan
Will the Minister give way?

§ Dawn Primarolo
First, I shall finish the point. The hon. Gentleman presented me with a series of challenges. He is right that it is an important issue, and those studying tonight's debate will be interested in the Government's response.
Dependence on the high margins earned from insurance means that commission rates on holiday sales are kept low. That benefits tour operators, for which that 259 commission is a significant overhead, and it helps to keep holiday prices down. It is the tax take from those holidays which is affected.
The hon. Gentleman rightly pointed out that the higher rate of tax does not apply to sales of insurance from other, non-travel outlets. That tax structure reflects two key points. Those other insurance providers do not sell taxable goods and services, so they cannot shift their margins to avoid tax. I appreciate the point that the hon. Gentleman made on that. We would have to consider that carefully before we included them in any anti-tax avoidance measure. Furthermore, the price differential in the marketplace suggests that travel insurance is not a price-sensitive product. How can it be, when a travel agent can charge £20 more per policy and, even without the incentive of discounted holidays, can still manage to sell travel insurance to 90 per cent. of its customers?
Given those factors, the previous Government decided to apply the higher rate to travel insurance sold by the travel industry. They apparently anticipated no significant impact on the marketplace. Clearly, we cannot rest on that assumption.
I have asked customs officials to continue to monitor the impact of the measure. They have done that in the travel sector in conjunction with the Association of British Travel Agents, which I have met and corresponded with about its concerns. Discussions continue, but, despite the figures quoted by the hon. Gentleman, many of which were in ABTA's recent letter to me on this subject, it has not so far been shown conclusively that travel agents have suffered a loss of market share in travel insurance that can be attributed to the price effect of the higher rate of insurance premium tax.
It is relevant to note that the 1996 survey conducted by Mintel before the advent of the tax change showed that travel agents were losing market share even then. However, I shall consider carefully what the hon. Gentleman said. I shall study the representations that I am currently receiving on this subject. I shall certainly give the matter my attention in the run-up to the Budget, and I shall try to deal with the points that the hon. Gentleman made.

§ Mr. Ronnie Fearn (Southport)
The hon. Lady mentioned that she had spoken to ABTA and that it had written to her. Does she agree that the two surveys that it carried out show a loss of commission of 34 per cent? That commission will be lost by the small, independent business person, rather than by the big boys: and we know who the big boys are. If that happens, we shall lose the small travel agent with two, three or up to six staff, which we have had for many years. Those findings are pretty 260 direct, and I do not know where she will find a more convincing survey. Can she assure us that there will be no job losses?

§ Dawn Primarolo
The letter from ABTA quoting 34 per cent., which the hon. Gentleman mentioned, has literally only just been received in my office. I should caution him that one should determine how surveys are conducted and whether they can withstand the rigours of proper investigation. When I met those at ABTA, they were very happy with the proposal that they should discuss the proposed points with Customs and Excise officials. They said that they were conducting further work, and I presume that the letter is a result of that further work.
I am sure that hon. Members will agree that, before taking a decision on the issue, the Government should continue to examine carefully the information that is being produced. The Government's first action must be to defend the Revenue. However, if there is an issue that must be addressed, it will be addressed. I have told the hon. Member for Galloway and Upper Nithsdale that, in the run-up to the Budget, I shall very carefully consider the issues that have been raised by the industry. I shall not, however, be making any announcements in this debate.

§ Mr. Alasdair Morgan
In the earlier part of her reply, the Minister mentioned the necessity of taxing excessive margins—which seems to be a new principle in taxation. I thought that profit margins were properly taxed by corporation tax, and that big tax was taken off firms that made big profits. The idea that we have a tax to attack different margins on different goods sold by the same person is a bit bizarre. Will that principle be applied to supermarkets, for example? Is the same profit margin possible in selling a pineapple as in selling a Kit Kat? I think not. How far is the Minister proposing to take that new concept?

§ Dawn Primarolo
The hon. Gentleman is not doing his case any good. I have explained to the House why the previous Government included specific measures in primary legislation. If he scrutinises Hansard a little more carefully, he will see exactly what happened in that Committee. I have told him in this debate that those matters are being carefully considered, and I have explained the Government's current position.
Our willingness to continue to review—which has constantly been expressed to the industry—shows that we are prepared to take action, if evidence substantiates that action is necessary. To date, however, that evidence has not been supplied. The Government continue to examine the matter in this important time before the Budget.