§ Question proposed, That the clause stand part of the Bill.
§ Mr. Prisk
Clause 20 inserts a new section 43AA into the Valued Added Tax Act 1994. It does so to stop what the Treasury sees as abusive arrangements whereby a jointly owned entity can join a VAT group even though it is run by and for the benefit of an external third party.
We believe that the Government should delay implementation because the potential unintended consequences of the measure could prove damaging to UK jobs, and that they should first seek to sort out the underlying anomaly. At the heart of the issue is the nature and role of companies outsourcing work and the rapidly increasing trend towards offshore outsourcing. I think that it is fair to say that offshore outsourcing has changed almost beyond recognition during the past two or three years.
In just the past few months, HSBC, Norwich Union, Lloyds TSB and Abbey National collectively outsourced about 9,700 jobs to India, and in a cost-conscious global economic environment, that trend is likely to grow. Commercially, many financial institutions prefer to outsource non-core activities to service providers, which are often companies that specialise in an activity and are therefore able to maximise efficiency. Because financial institutions such as banks are exempt for VAT purposes, they do not charge VAT to customers, but the quid pro quo is that they cannot recover input VAT when they buy services and goods. Services or goods cost banks 17.5 per cent. more than they cost companies that are not exempt.
If a bank reorganises and decides to outsource a back office function or other similar function, it will incur an additional 17.5 per cent. cost that it, unlike other 832 companies, cannot recover. However, if a bank were to outsource to an overseas supplier in, for example, India, in many instances it would not face the 17.5 per cent. charge. UK back office suppliers, and therefore the many locations it this country that have a strong reputation in that field, often find themselves at a significant price disadvantage against their overseas competitors.
Nigel Roxburgh, the co-founder of the National Outsourcing Association, recently pointed out:If one has to claw back … the 17.5 percent tax, the best way in which to do it would b to move offshore. The … proposal could inadvertently help off shore suppliers, which are not subject to this tax".Clause 20 fails to address that anomaly, and instead changes the rules, which the Government perceive are being abused.
The anomaly should be addressed first, so that if and when a bank chooses to outsource a call centre or similar activity, companies based in, for example, Wentworth, Bristol or Bolton can compete on level terms with Mumbai, Hyderabad and New Delhi. Creating a level playing field for British workers should surely come before a tax clampdown. Indeed, if these proposals lead to more offshore outsourcing, the tax yield will, ironically, fall. That is a classic example of how careful Governments must be in clamping down on alleged tax avoidance—hit too hard or hit inaccurately, and the end result is the reverse of that intended.
Allied to that is the danger that the tax clampdown does not work as intended and exacerbates the situation. In response to the Government's consultation, the Law Society said:We strongly believe that these proposals will not achieve the Government's aims and may well give rise to increased opportunities for avoidance … We also believe that the need for new legislation is not yet demonstrated, given the powers that HM Customs admit they a ready have, but have chosen not to use.Serious experts in the field clearly have their doubts. Although I recognise that the Government adjusted the final proposals after the consultation, I must say to the Economic Secretary that corporates and their tax and legal experts have serious reservations about whether the proposals will achieve their stated purpose.
There is a third reason why the Government should not seek to proceed with their plans. The Department of Trade and Industry is currently engaged in two reviews that relate to offshore outsourcing. One is a review of UK call centres and their competitiveness, and the report on the initial study will not be published until next month at the earliest. The other is the trade and industry White Paper, which is due to be published in the summer, although that may, of course, become the autumn. Both those reports need to be considered carefully by Ministers, then by this House, yet the clause contains a tax proposal that will have a direct impact on all these issues and cuts across those reviews. Surely, before pushing ahead with implementing the tax, the Government should consider the situation as a whole and report back to the House. Whatever happened to joined-up government?
833 There are three reasons why we believe that the Government should delay the implementation of the clause. First, we want to ensure that any unintended consequences of the change have been carefully considered and are understood by business, which is not the case at the moment. Secondly, we, want to enable the whole question of the international competitiveness of call centres and other service providers to be considered in the round, and moving ahead with the tax before the reports are published makes that difficult to achieve. Lastly, we want to encourage the Government to focus on the first priority, which should be to create a level playing field for British workers who are trying to compete with overseas companies. Business and Government need time—not necessarily a year or two; perhaps only a matter of months—to get this right. I hope that in his reply, the Economic Secretary will recognise that and explain why the. Government are putting a tax squeeze ahead of creating a level playing field for British workers.
§ Mr. Laws
We understand and support the stated aim of clause 20, which is designed to prevent large companies from avoiding VAT on high-value taxable services that are bought in by third parties. However, the question for us and for those whom we have consulted is whether the manner in which it is implemented will involve tests that are too complex or unworkable in practice. It is fair to say that practitioners have differing views on whether the Government's consultation on the clause was effective. The Chartered Institute of Taxation commended it, noting that the proposals in the Bill differ significantly from the initial proposals and stating:This is a case where consultation has worked well.
However, several other practitioners told us that their comments about the potential complexity of the provisions were ignored and that they are worried that they will impose a large regulatory burden on many firms and their advisers. It has been pointed out that the clause gives substantial powers to the Treasury and that once it has been brought in it may be difficult to remedy any problems at a later date. Although it is recognised that Customs needs to be able to deal with the abuse of VAT grouping, many practitioners believe that the clause as drafted is inappropriate and that the regulatory impact assessment understates the complexity of the proposed tests. They do not think those tests can necessarily be delegated to relatively junior employees, as is implied in the cost assessment that was carried out, and do not believe that the time and cost estimates are realistic. Several are aware of cases in which applying even the existing tests, which are less onerous than those in the Bill, required a long period—up to a day—in consultation with an in-house barrister. In practice, most businesses would need to seek professional advice in relation to applying the tests.
Our concern, which touches to some extent on the points raised by the hon. Member for Hertford and Stortford (Mr. Prisk), centres on whether the Government have yet listened sufficiently to the views of practitioners and have put in place tests that are simple enough to he applied relatively straightforwardly without adding to burdens on business. If the Government took a little more time to consult the practitioners, they might be able to address their concerns.
§ John Healey
The Committee will be aware of the Government's commitment to reducing the revenue losses that have historically faced the VAT system and, in particular, of our commitment to tackling artificial VAT avoidance schemes and closing loopholes in the law that allow tax leakage. This was set out by the Government in "Protecting indirect tax revenues", which we published alongside the pre-Budget report in 2002.
VAT grouping is an area in which we have seen some aggressive tax avoidance. As a result, the Government proposed changes to the rules on VAT grouping eligibility in the 2003 pre-Budget report. The original proposal was to align the grouping rules with the rules on consolidation of subsidiaries in group financial accounts. A consultation paper was formally published on 23 November 2003, and a summary of the responses to it was published alongside the Finance Bill on 8 April this year. The summary spelled out the Government's modified proposal, which we developed in the light of the comments from respondents, and I hope that the hon. Member for Yeovil (Mr. Laws) will accept that we took the views of practitioners into account. Indeed, the hon. Member for Hertford and Stortford (Mr. Prisk) acknowledged the modification, and the way in which we had responded to the points raised in consultation.
It might help if I briefly explain the nature and operation of the grouping rules. I think that the hon. Member for Hertford and Stortford will then see that this is not a measure directed at outsourcing. Grouping is a business facilitation measure. Members of a VAT group are treated, for VAT purposes, as a single taxable person. This means that no VAT is charged or reclaimed on supplies of goods or services between the group members. In short, companies in the VAT group are in the same VAT position as divisions within a single company.
One benefit of VAT grouping is not having to register all the companies in the group separately for VAT. There is also a tax benefit when a member of the group would otherwise be unable to recover all the VAT incurred on purchases from other group members—for example, a partly exempt bank, insurance or property company. The Government accept this revenue cost as part of the normal operation of grouping, as part of our interest in seeing this business facilitation measure continue. However, some businesses attempt unfairly to exploit the VAT grouping rules in order to avoid tax and gain a tax benefit that goes beyond the normal operation of grouping. Some might argue that they are merely correcting the flaws in the VAT system. Others might argue. as the hon. Member for Hertford and Stortford did, that the new proposals on VAT rules will somehow act against business decisions to outsource in the UK and force outsourcing operations abroad.
I do not accept that argument. Our evidence shows that VAT is not a decisive factor for companies deciding whether or where to outsource. For example, recent research shows that a decisive factor is the cost per employee for wages and property, which is £27,000 a year in London and £18,500 in Sheffield. It is probably slightly less in Wentworth. However, it is £6,500 in Mumbai. Those figures show the significant cost savings that are often behind decisions to outsource.
835 The call centre industry in the UK does not think that it is in serious decline. The Call Centre Association surveys its members quarterly, and it published its most recent findings in December 2003. When its members were asked:Do you agree with the claim that the call centre industry in the UK is in significant decline?",76 per cent. said no and only 12 per cent. said yes. The 76 per cent. who said no expected offshore growth to continue, but they also expected it to be outpaced by market expansion, leading to continuing growth of the industry in the UK. Indeed, some noticed a trend to repatriate work to the UK because of quality difficulties experienced offshore. I think that the hon. Member for Hertford and Stortford overstated his case on that point.
§ Mr. Howard Flight (Arundel and South Downs) (Con)
To revert to the point that the Economic Secretary was making in leading up to this, will joint venture company situations, where it may be administratively appropriate to be part of a group, be possible under the new measures? My understanding is that they would effectively be ruled out as a result of where the lines are being drawn, although there may be a perfectly good practical and non-tax avoidance case for them.
§ John Healey
It will depend on the nature and application of the test that we will devise and implement in secondary legislation. Principally, it will turn on who draws the principal benefit from the joint venture company. I shall explain further as I make progress.
The measure that we propose does two things. First, it amends the law on VAT grouping to make it clear that a company or other corporate body cannot be in two VAT groups at the same time. That clarifies the position but does not change anything in practice for existing VAT groups. Secondly, the measure will stop abusive grouping arrangements by changing the rules for VAT grouping eligibility. Currently, a company is able to join a VAT group even though it is run by, and for the benefit of, a company that is not part of that VAT group. Those are the criteria that we want to tighten up.
§ Mr. Flight
That reply leads on to the second related point. Can the Economic Secretary assure the House that there will be sufficient clarity in the secondary legislation in relation to this territory? Many in the business community are concerned that there will be greyness. Can he assure us that, without it being too extensive, it will be as clear as possible?
§ John Healey
If the hon. Gentleman will bear with me, I will come on to that point. I am confident that I can provide that degree of assurance in relation to clarity. There will also be consultation, which will also answer the point made by the hon. Member for Yeovil about concerns over complexity.
The arrangements that we want to tackle result in a substantial revenue loss to the public purse, which is estimated this year, if we took no action, at £75 million. 836 Alongside those losses to the Exchequer, the companies concerned obtain a significant advantage over their competitors.
Since 2001, Customs has used its "protection of the revenue" powers to stop such abuses when it finds them. This has been well known, and Customs has published business briefs on its actions and activities. Nevertheless, the abuse has not stopped. The reason is that Customs can lake action only once it has found a company using the scheme, which could be some years after the event. Even then, Customs cannot recover the VAT that has already been lost, so there is a limited downside risk to entering one of these schemes at present.
A further concern that has been raised about the current position is that, with the ability to challenge and close such schemes resting on Customs' revenue protection powers businesses have complained that there is a degree of uncertainty about what is and is not unacceptable. The legislative solution proposed in clause 20 resolves those concerns.
These schemes create unfair competition, which should be rectified without the delay that the hon. Member for Hertford and Stortford urges. The revenue saved by such action against these schemes this year is estimated at £50 million. The change is not being sprung on business without notice or without dealing with their concerns. Most respondents to the consultation accepted the need to act on the abuse to get, as one person put it, a level playing field. However, they said that the proposed changes would impose extra costs on VAT groups generally, in order to tackle a small minority of abusers. We responded to those concerns. The clause that we are examining today does not change group eligibility criteria for the vast majority of VAT groups who are not involved in this abuse. Instead, it gives the Treasury power to make an order that can change the eligibility criteria in limited circumstances, targeted at the situations in which abuse can arise.
I can confirm that the order will be subject to parliamentary scrutiny under the affirmative statutory instrument procedure. I can also confirm that I will ensure that it is published in draft in advance. I hope that that helps to deal with the anxieties expressed by the hon. Member for Yeovil, and will give the hon. Member for Arundel and South Downs (Mr. Flight) an opportunity to scrutinise the provisions for the "greyness" that is worrying him.
The clause is not about outsourcing; it is intended to prevent abuse of the VAT grouping eligibility rules, to level the playing held for compliant businesses—particularly small businesses—and to give businesses in general more legal certainty. It constitutes an effective response to aggressive VAT avoidance. It is what is needed, and what is needed now. It is a proportionate and timely response, and I commend it to the Committee.
§ Question put ana agreed to.
§ Clause 20 ordered to stand part of the Bill.