§ '.—(1) For subsection (2) of section 71 of the Taxation of Chargeable Gains Act 1992 (allowable losses of trustees treated as transferred to a person becoming absolutely entitled to settled property) there shall be substituted the following subsections—
§ "(2) Where, in any case in which a person (`the beneficiary') becomes absolutely entitled to any settled property as against the trustee, an allowable loss would (apart from this subsection) have accrued to the trustee on the deemed disposal under subsection (1) above of an asset comprised in that property—
- (a) that loss shall be treated, to the extent only that it cannot be deducted from pre-entitlement gains of the trustee, as an allowable loss accruing to the beneficiary (instead of to the trustee); but
- (b) any allowable loss treated as accruing to the beneficiary under this subsection shall be deductible under this Act from chargeable gains accruing to the beneficiary to the extent only that it can be deducted from gains accruing to the beneficiary on the disposal by him of—
- (i) the asset on the deemed disposal of which the loss accrued; or
- (ii) where that asset is an estate, interest or right in or over land, that asset or any asset deriving from that asset.
§ (2A) In subsection (2) above 'pre-entitlement gain', in relation to an allowable loss accruing to a trustee on the deemed disposal of any asset comprised in any settled property, means a chargeable gain accruing to that trustee on— 718
- (a) a disposal which, on the occasion on which the beneficiary becomes absolutely entitled as against the trustee to that property, is deemed under subsection (1) above to have taken place; or
- (b) any other disposal taking place before that occasion but in the same year of assessment.
§ (2B) For the purposes of subsection (2)(b)(ii) above an asset ('the relevant asset') derives from another if, in a case where—
- (a) assets have merged,
- (b) an asset has divided or otherwise changed its nature, or
- (c) different rights or interests in or over any asset have been created or extinguished at different times,
the value of the relevant asset is wholly or partly derived (through one or more successive events falling within paragraphs (a) to (c) above but not otherwise) from the other asset.
- (a) for determining for the purposes of this section whether an allowable loss accruing to the trustee, or treated as accruing to the beneficiary, can be deducted from particular chargeable gains for any year of assessment; and
- (b) for the making of deductions of allowable losses from chargeable gains in cases where it has been determined that such an allowable loss can be deducted from particular chargeable gains.
§ (2D) Those rules are as follows—
- (a) allowable losses accruing to the trustee on a deemed disposal under subsection (1) above shall be deducted before any deduction is made in respect of any other allowable losses accruing to the trustee in that year;
- (b) allowable losses treated as accruing to the beneficiary under this section, so far as they cannot be deducted in a year of assessment as mentioned in subsection (2)(b) above, may be carried forward from year to year until they can be so deducted; and
- (c) allowable losses treated as accruing to the beneficiary for any year of assessment under this section, and allowable losses carried forward to any year of assessment under paragraph (b) above—
- (i) shall be deducted before any deduction is made in respect of any allowable losses accruing to the beneficiary in that year otherwise than by virtue of this section; and
- (ii) in the case of losses carried forward to any year, shall be deductible as if they were losses actually accruing in that year."
§ (2) This section applies in relation to any occasion on or after 16th June 1999 on which a person becomes absolutely entitled to settled property as against the trustee.'.—[Dawn Primarolo.]
§ Brought up, and read the First time.
§ The Paymaster General (Dawn Primarolo)
I beg to move, That the clause be read a Second time.
The new clause is intended to prevent avoidance of capital gains tax through the purchase of losses realised in trusts. We are introducing it now because it is only in the past six weeks or so that the Inland Revenue has gathered evidence of significant exploitation. When we announced the measure on 16 June, our assessment of the potential loss of revenue, if the schemes of which we had evidence were to succeed, was about £500 million. Since then, further schemes have come to light, and the estimate has now risen to £750 million. That is exploitation on a grand scale, and it is entirely unacceptable. We have made it clear that we shall take prompt action to stamp out 719 avoidance of this kind. That is why we are taking action now, and why we shall continue to take such action whenever the need arises.
Capital losses realised by trustees on assets in a trust can normally only be set against capital gains of the trust. The losses cannot be transferred to beneficiaries of the trust, except in one situation: when a beneficiary becomes absolutely entitled to settled property under the terms of the trust—in other words, when the property of the trust becomes the property of the beneficiary. Any capital loss arising on that occasion that cannot be used by the trustees is transferred to the beneficiary.
Those rules, which have applied since 1965, are being exploited in the following way. Trustees of trusts with large losses that cannot be used to offset gains within the trust create an interest in the trust property in favour of a beneficiary. That interest is contingent on a certain event occurring—an event that is almost bound to occur—after a short period.
Steps are then taken for appropriate portions of the interest to be sold to individuals and companies that have gains to shelter. Those individuals and companies become new beneficiaries of the trust. When the appointed day arrives—usually after a very short time—the appropriate amounts of losses pass to them. In such cases, huge losses are available. The Revenue is aware of one scheme where a manufactured loss of £1 billion is involved. The effect is that people with gains can use losses that they have not incurred to eliminate their tax liability. That is wholly contrary to the purpose of the legislation.
The mischief is not confined to cases where new beneficiaries purchase an interest in the trust. The beneficiaries could be appointed by the trustees, or the interest could be transferred to the ultimate beneficiary via an intermediary. It is because of those difficulties that confining action to the purchase of interests in trusts would not solve the problem.
The Revenue has been aware of the possibility of loss buying in those circumstances for some time, but there has been no evidence of a widespread problem until very recently. However, as I have said, in the past few weeks, evidence has emerged of very large losses being manufactured in trusts purely to take advantage of those rules by profiting from their sale. The scheme takes a number of forms, but all involve the creation of losses within UK trusts, or the use of UK trusts with existing losses, so that the trust loss can be sold to prospective purchasers.
Although the Revenue will challenge the validity of those schemes under existing law, the scale of the problem is so large that we are not prepared to stake the potential loss of so much tax on the possibility of a favourable outcome in the courts. The only sure way to stop the sale of all future trust losses is to attack the source of the problem; I am sure that hon. Members agree.
The new clause provides for losses on trust assets sold by the trustees to be allowed within the trust under the normal rules. If a beneficiary becomes absolutely entitled to an asset in the trust and a loss is deemed to accrue on that occasion, and if the trustees cannot offset that loss against gains arising at that time, or earlier in the year, the loss will be transferred to the beneficiary, but the beneficiary can then use that loss only against subsequent gain arising on that asset.
720 That is how the legislation should work and that is how it will work from now on. The new clause not only stops a serious potential loss of tax, but puts right an anomaly in current legislation, which should have been corrected a long time ago. I commend the new clause.
§ Mr. Quentin Davies
I have some sympathy for the Paymaster General's approach to the problem. She has set out her thinking clearly, for which we are grateful. However, several points concern me. I shall ask her some questions. I hope that I receive clear and sensible answers, so that we can have a serious dialogue across the Dispatch Box. I hope that she does not follow the example of the Financial Secretary to the Treasury, who tried to avoid all my questions although, finally, she made the declaration that I wanted all along, so I suppose that we must be grateful to her for that.
Two things concern me most about the new clause. It seems to run counter to, and potentially to damage, two principles that should characterise our tax law, or any rational and fair tax law. I fear that the new clause moves our law on capital gains tax away from those two principles.
The first, which is terribly important, is even-handedness between losses and gains. If trustees can distribute gains and if those gains are subject to tax in the hands of the recipient and beneficiary, it should be axiomatic that trustees can distribute losses and that those losses can be used freely by the beneficiary, to be set against gains for which he or she might otherwise be liable elsewhere on his or her portfolio of investments. We seem to be moving away from that principle of equivalence of treatment between gains and losses.
Secondly, the new clause poses the danger of moving us away from the principle that an individual should be taxed on the basis of his or her income or capital gains to the greatest extent possible, irrespective of whether those assets are held, those incomes or gains derive from a beneficial interest in a trust, or whether they are held directly.
We know very well that, for many years—although it is not always the case—trusts were established deliberately to avoid tax legally. However, the previous Government's reforms, which have been implemented in the past few years, to modernise our tax system have all attempted to remove that anomaly in tax law, and to ensure that people are taxed on their real financial position—on losses or gains for capital gains tax; on income for income tax—regardless of whether income was channelled through, or assets held, in a trust. Now, we are moving away from trying to make such a reform.
There may be very good reasons for establishing a trust, and I do not want anyone to get the impression that Conservative Members are against establishing one. There are extremely respectable—indeed, valuable—reasons for establishing a trust, such as to promote a particular cause or objective, to protect the interests of minors, or to protect family property down the generations by preventing one generation from squandering it all. Those are all sensible and responsible uses of a trust. However, so far as possible—this was the thrust of the previous Conservative Government's reform of trust taxation—trusts should not be established simply to shelter a given income flow or potential capital gains from tax to which the beneficiary, without a trust, would be liable.
721 New clause 4 moves against the previous Government's reforms, and in the direction of creating a situation in which it is less advantageous to have losses credited to one in a trust, as it would not be possible to offset those losses against gains that might arise elsewhere in one's portfolio. Such an offset should be allowed if gains distributed to the beneficiary are similarly taxable.
Those are my general concerns, and those principles certainly inform the Opposition's thinking and the way in which we consider tax. I should like the hon. Lady to tell us, very frankly and seriously, whether she generally shares our principles in the matter; and, if she does, how she justifies moving the proposals in new clause 4 and, regrettably, taking the Taxation of Chargeable Gains Act 1992 away from those principles. If she does not share our principles, perhaps she will tell us why she does not.
The hon. Lady justified the Government's proposals entirely on the ground that they would deal with potential tax avoidance, and she gave some alarming figures on that. I am, again, grateful to her for her extremely intelligent and sensible exposition of the Government's thinking on the matter. She explained why the Government feel that there would not be sufficient protection if we legislated that gains could be enjoyed for purposes of setting against losses only when the beneficiary to which the gains were distributed had not purchased his or her interest in the trust—as other mechanisms would be available that could lead to the same abuse that she described. An existing beneficiary could, for example, nominate another beneficiary, or the trustees could nominate another beneficiary.
My initial reaction to those examples is that, presumably, without some financial consideration, no one would nominate someone else to benefit from gains or useful losses that were attributable to him or her. I should think, therefore, that the approach that the hon. Lady rejected might be more promising than, at first sight, she believed they were. I am quite certain that, in practice, any trustee or beneficiary who is giving away his or her rights is receiving some form of compensation. Therefore, if we legislated to ensure that such ultimate beneficiaries could not enjoy the benefits of losses they had thus acquired, we might solve the problem. I hope that she thinks a little further about whether there might be some other way to approach the issue which would not do violence to the key principles that I have just enunciated.
Another approach that is worth exploring and on which I should like a response from the Paymaster General would be to protect those who are beneficiaries by virtue of the original trust deed. They might not be named in the trust deed because they might be a subsequent generation, but they would be of a category provided for in the original trust deed rather than secondary or tertiary beneficiaries who had been nominated or who had purchased their interest in the trust through the avenues that the hon. Lady set out. I make my suggestions in a constructive spirit, because I share the Minister's concern about the potential loss of tax revenue and I am grateful to her for the extent to which she has taken us into her thinking.
I do not doubt the hon. Lady's personal sincerity, but the new clause aroused my suspicions. Eliminating the risk of tax avoidance is not a full and credible explanation 722 of the motives behind the Government's proposals. Only a small part of the new clause—subsection (2)—addresses potential avoidance. Subsection (2D) sets out the rules for the order in which losses can be set against gains for the purposes of determining capital gains tax liability. Subsection (2D)(a) says:allowable losses accruing to the trustee on a deemed disposal under subsection (1) above"—deemed disposal is when an asset is transferred from a trust to the direct ownership of the beneficiary—shall be deducted before any deduction is made in respect of any other allowable losses accruing to the trustee in that year".What the devil does the order in which losses are set off against gains have to do with tax avoidance? If someone set up an artificial scheme to generate losses in a trust to be set against gains from elsewhere to reduce CGT liability, they would not need to be told by legislation that the losses had to be used in that way because they would have gone to the trouble of creating those losses for the purpose of reducing CGT liabilities. That arouses great suspicions, which I hope that the hon. Lady will be able to allay. If she does, we shall support a well considered attempt to attack a genuine source of potential tax avoidance.
Subsection (2A) refers toa disposal"—by the trustees—which, on the occasion on which the beneficiary becomes absolutely entitled as against the trustee to that property, is deemed under subsection (1) above to have taken place; or(b) any other disposal taking place before that occasion but in the same year of assessment".Taken together with subsection (2D), which I quoted earlier, the effect will be that trustees who cannot make use of all their losses will not be able to distribute those other than the deemed losses that may have been incurred to the beneficiary, because they will have had to set off against any gains the deemed losses in the first instance. Once those are exhausted, they may find themselves with other additional losses that cannot be transferred to the beneficiary. Trusts will lose the ability to use certain losses.
Is the new clause an attempt to prevent a new source of tax avoidance or is it an attempt to change the existing regime applying to trusts to make it less favourable to honest trusts, which will no longer be able to use the totality of losses that is currently available to be set off against CGT-liable gains? That is what I want to know.
Why are we going in for this complication? Why do we have these rules on the order in which the losses must be applied? Is not it incredible—or non-credible—to suppose that if artificial losses are created, they will not be used immediately to offset gains? Why would people otherwise take the trouble and expense to set up these artificial schemes?
We want to know whether these matters have been thought through. Does this proposal really represent the bare minimum required to address the notional or potential loss? Will the position of entirely innocent trusts—which continue to administer themselves on the same basis and are not the source of any artificial schemes—be made considerably less favourable by what I believe to be a far too bluntly drafted clause?
§ Dawn Primarolo
As this is the first time that I have addressed the hon. Member for Grantham and Stamford (Mr. Davies) from the Dispatch Box since his promotion, may I belatedly congratulate him and welcome him to the Opposition Front Bench?
I will try to deal with the points raised by the hon. Gentleman, which are very important. The Government were faced with a serious situation. The current tax rules in this area are anomalous. Trustees of trusts are taxed as a separate person from the beneficiaries for capital gains purposes, and are chargeable on all gains made on trust property at the special rate.
It is more than a little odd that, in those circumstances, the rules should allow losses on trust property to be passed to beneficiaries to set against gains on property which have not emerged from the trust. Losses realised by the trustees ought to be allowed only against property which is in the trust or which has come out of the trust. That is what the new clause is trying to deal with.
The hon. Member for Grantham and Stamford asked about the purchased interests, and why we have not attacked them. There would be a real difficulty in establishing whether a trust interest had been purchased. Under some arrangements, the trustees and the beneficiaries may be bypassed altogether, with the money—because there is a payment—going directly from the purchaser to the scheme organiser or the loss creator.
It would have been futile to introduce legislation which missed the mark and allowed some schemes to escape and provide opportunities for other schemes to be reworked to get around the rules. The hon. Member for Grantham and Stamford asked whether that may still be the case. We have tried to write the rules in the new clause in such a way as to prevent that from happening in what is a complex area.
We have tried to avoid immensely complex legislation, which could deny the transfer of loss to beneficiaries who might be genuinely added at the discretion of the trustees. That would be wrong in principle. The only situation where we consider it justified for losses to continue to be transferred from a trustee to a beneficiary is where the asset on which the loss arises is transferred to the beneficiary.
§ Mr. Quentin Davies
I am well aware of what the proposals are. I am asking the Paymaster General to think a bit further about a limitation that would exclude beneficiaries who have purchased their interest in the trust. Her original response was that such beneficiaries would not necessarily have had to purchase their interest because they could have been nominated by the trustees or a beneficiary, but it is fundamentally implausible that the trustees or a beneficiary would give away their interest—which must, by definition, have a value if it serves a purpose in a tax avoidance scheme—for no consideration.
Now, the Paymaster General says that the sums concerned might have been transferred from the ultimate beneficiary—the beneficiary of the artificial scheme—to the organisers of the scheme, with the trustees and the beneficiary having no benefit, but it would be a breach of trust law for a trustee simply to give away such an interest. A provision based on someone having directly or indirectly purchased an interest in a trust is a great deal more robust than she originally thought.
§ Dawn Primarolo
I do not agree. After careful consideration we came to the conclusion that such a 724 provision would be difficult and complex and would not deal with the abuse that is clearly taking place. The Government wanted to get to the root of the abuse without introducing too much complexity in the legislation. The capital gains tax system taxes the gains of trusts separately from those of individuals. The trustees are treated as different persons from the beneficiaries for CGT purposes. The new clause is an anti-avoidance measure. It does not alter the fundamental basis for taxing trusts.
§ Mr. St. Aubyn
Why, in closing the loophole, are the Government shifting the principle of tax neutrality from the beneficiary to the trust, introducing a much tighter definition that is very unfair to those who were given much fairer treatment under the previous Government's reforms over 18 years?
§ Dawn Primarolo
To ensure that the abuse is stopped. The potential loss of tax is so great that we had to act. If tax planners introduce such complicated and ingenious ways of getting round the intent of legislation, they must expect the Government to respond.
§ Dawn Primarolo
The complaint of the hon. Member for Grantham and Stamford seems to be that the Government have gone too far and that there were other ways of dealing with the matter. I have explained that, despite the fact that we considered some of his suggestions carefully, the only way of guaranteeing that we deal with the root problem is embodied in the new clause, which I commend to the House.
§ Question put and agreed to.
§ Clause read a Second time, and added to the Bill.