INVESTMENT INCOME OF SINKING FUNDS AND SERVICE CHARGE FUNDS (No. 2) (Hansard, 3 July 2002)

§ Mr. David Heath (Somerton and Frome)
I beg to move, That the clause be read a Second time.
I hasten to assure the House, after the comments made during the previous speech, that this new clause seeks to deal with the interests of those on very low pay, rather than the rich. The matter was drawn to my attention by constituents who live in sheltered accommodation. They live in what was Royal British Legion sheltered accommodation, but is now run by a housing agency at Mow Barton in Martock. The issue was raised by my 358 constituent Commander Barkaway, who was very concerned by what he had construed as a change in tax law that was affecting him and fellow residents.
My constituent is concerned about the taxation of the money that residents are required to pay into a trust to deal with repairs and dilapidation; what is known as a sinking fund. Residents are required, as part of their tenancy agreement, to pay a set amount into a fund that is used for running costs, cleaning and minor repairs, and is set aside for more major repairs such as to roofs.
The problem is that the income accruing on that fund is taxed at a rate of 34 per cent., which, the residents put to me, is a punitive rate for those on low incomes. They had assumed that there had been a change in the law of which they had been unaware. I am not an expert in this area and I assumed that there must have been a change in the law that I had not noticed. In fact, it was a change in interpretation of the law by the Inland Revenue that gave rise to the concerns. The Inland Revenue issued guidance in October 1998, because although some trusts were apparently applying the law—the unified 34 per cent. tax rate—correctly, others were not, and were continuing to charge a rate equivalent to the basic standard rate. The guidance suggested that that was an incorrect interpretation of the law, and needed to be amended.
There was also some confusion because, under section 42 of the Landlord and Tenant Act 1987, the money must be held in a trust, and must therefore be taxed as if it were a trust. However, there are housing schemes that are outside the requirements of the 1987 Act, as well as registered social landlords and other exempt landlords. The Inland Revenue again issued guidance, in August 2000, suggesting that even those trusts that did not fall within the precise terms of the 1987 Act would also comprise a trust, and must be taxed on the same basis.
As I said, this has given rise to considerable concern. It is not surprising that lay people, myself included, felt that there had been a change in the tax situation. Even those who are supposed to advise us on these matters made the same mistake in the newspapers. According to a November 1998 edition of The Sunday Times: People who own leasehold flats could face a big increase in service charges after a decision to change the way the money they set aside for repairs is taxed. Many leaseholders will now have to pay tax at 34 per cent., nearly half as much again as house-owners. The article goes on to discuss a new tax rate.
I ask the Minister not to dwell on the detail of the new clause. I readily accept that it is a vehicle for debate, not a proposal that is necessarily complete. I made two attempts to table the original new clause 15—it, too, was on the original amendment paper, but it was not selected for debate—and I also attempted a slightly more complex version. The new clause before us is not perfect. First, it does not identify the specific groups that I am seeking to help; secondly, it removes them from tax altogether, rather than returning them to the basic tax rate. That would be a more appropriate position, but it would require a much more complex new clause.
I hope that the new clause stimulates debate—not only here but within the Treasury—on how we might deal with this anomaly. I do not argue with the fact that trusts have been used as a means of avoiding tax in several ways, and I have no doubt that a trust such as this was equally capable of being abused in that way. As I understand it, the unified tax rate was introduced to establish an 359 approximation of the rate that might apply to a range of beneficiaries to the trust—some paying the basic rate, others paying the higher rate, and others still falling outside the tax rate altogether.
The problem is that the taxation of trusts is not linked to the circumstances or tax position of any particular beneficiary—in this case, the tenant. I cannot believe that the Government or the law intend that people whose income falls below the tax thresholds, or who would normally pay the basic rate—and who, if they owned their own property, could put the money aside on that taxable basis to pay for repairs—should, because they are required by this legislation to put the money into a sinking fund that forms a trust, be taxed at a much higher rate. I ask the Minister to give serious consideration to finding a way to help such people, who are often pensioners in reduced circumstances, so that they can avoid paying excessive tax for a purpose—keeping a roof over their heads—that is wholly beneficial to them and to society.

§ Ruth Kelly
As the hon. Member for Somerton and Frome (Mr. Heath) has set out, the new clause aims to remove the investment income of certain sinking funds and service charge funds from income tax or corporation tax. Those funds do not pay corporation tax but they pay income tax at the special rate that is applicable to trusts.
I understand the hon. Gentleman's motivation and, as requested, I shall not dwell on the detail of his proposals. However, there is no rationale for exempting that type of income from tax or for taxing it purely at the lower rate. If the funds were held by individuals in a bank or building society account, the interest arising on that investment would be taxed in the normal way. The fact that funds are held in trust is no reason to exclude them from tax.
The income from the funds is taxed in the normal way for that type of trust, which can be used for a wide variety of purposes. The new clause refers to the Landlord and Tenant Act 1987, which covers such funds whether they are set up for people living in low-cost housing association flats or in leasehold apartments in very well-to-do areas. The rate at which trustees pay tax on income is set to take into account the wide variety of circumstances of those who put funds into the trust or who otherwise benefit from the trust, as the hon. Gentleman pointed out. Those funds are not just for poor tenants. They can be found across all types of housing.
The hon. Gentleman appears to propose that we try to identify those trusts that serve poorer tenants and separate them from those that serve wealthier tenants. That is impractical. In any event, the 34 per cent. rate, which the hon. Gentleman mentioned, is charged on the trustee, not the person who pays money into the trust or the beneficiary. It is set at a rate that takes into account the fact that beneficiaries of the trust may pay tax at the basic or higher rates, and that others might even be non-taxpayers. The rate is set at a level that minimises the opportunities for trusts to be used to avoid tax, because that cannot be right.
The hon. Gentleman suggests that there has been a change in the tax law, but there has not. The Inland Revenue issued guidance because some people were misapplying the tax rates and returning the income incorrectly.

§ Mr. Burnett
Perhaps the Minister could have a word with her colleagues in whichever Department deals with 360 housing these days to see whether the law could be amended to allow sinking funds to fall under the aegis of a limited company.

§ Ruth Kelly
I shall pass on the hon. Gentleman's suggestion, but as I understand the issue, it would be impractical to change the terms under which the trusts are taxed. For that reason and the others that I have given, I urge hon. Members not to accept the new clause.

§ Mr. Heath
I am grateful to the Minister for giving her attention to a serious attempt to assist a particular category of people. I understand the point that she makes about the difficulties in identifying such people in legal terms. My hon. Friend the Member for Torridge and West Devon (Mr. Burnett) has made a suggestion of some merit and another method might be to put some limit on the size of the sinking funds, so that those below that limit—which would normally apply to a smaller scheme and lower value properties—might fall outside the unified rate and have a lower rate applied to them.
I ask the Minister to give serious consideration to my case. It is not logical for someone who would not normally pay tax, or would pay tax at the basic rate, to be taxed at a much higher rate because by law they have to pay part of their income into a sinking fund. That is an anomaly that deserves closer attention. This is not the right time or place to pursue the matter further, but perhaps the Minister would write to me on the issue. I beg to ask leave to withdraw the motion.