Mr. Flight: At the end of the day, the purpose of clause 43 is to keep the UK competitive as a base for multinational businesses, when there are several costs arising from the Budget on other matters, and when the competitiveness of the UK has generally declined. The question at the centre of clause 43 is: are we competitive enough compared to, for example, Holland?
Ruth Kelly: I thank the hon. Member for Fareham (Mr. Hoban) for his amendment, which gives me an opportunity to put on record why we chose the threshold of 10 per cent. as opposed to any other number and why we did not devise a different, perhaps more complex test, to distinguish between shareholdings that are structural to a business rather than those that are simply a passive portfolio of investments. The desire to be able to distinguish between those two types of arrangements is the key to the threshold.
The rules must differentiate holdings in some way. During the consultation period, we explored the possibility of operating an alternative to a numerical test. We had hoped to devise a test that would distinguish absolutely between structural holdings and passive investment holdings, whatever the size of the holding. The test would have had to be sufficiently robust to be proof against manipulation according to whether gains or losses were expected. Unfortunately, it was not possible to devise such a test. That is why we settled on a numerical test, which has the merits of being easy to understand and straightforward to apply.
We listened to what business told us during the consultation period. It was content with the 10 per cent. figure. We believe that it will target the vast majority of structural holdings while excluding the bulk of portfolio holdings. It has been widely accepted as the most appropriate solution. To reduce the figure to 5 per cent., as proposed in the amendment of the hon. Member for Fareham, would considerably increase the number of portfolio investments that would qualify for the exemption. We accept that some holdings between 5 and 10 per cent. may be structural, and we have not completely abandoned the idea of seeking an alternative workable test to differentiate between the two. However, until such a test emerges, I
Column Number: 155am not persuaded that it would be right to abandon the threshold requirement.
The hon. Gentleman discussed the situation in other countries such as the Netherlands and Germany. A wide range of thresholds operates in other countries that have similar reliefs. The hon. Gentleman gave examples of two that have lower thresholds, but others apply higher thresholds. The key is that Governments structure the relief, including the qualifying threshold, to reflect their underlying policy objectives. The threshold that we have set makes what I readily admit is a fairly rough and ready distinction between portfolio and commercial investments. A balance must be found, and a threshold of 10 per cent. is the right level to set to avoid capturing the vast majority of portfolio investments. On those grounds, I do not support the hon. Gentleman's amendment.
Rob Marris (Wolverhampton, South-West): Do the Government intend in paragraph 8(1)(a) that it should be 10 per cent. of the company's ordinary issue share capital?
Ruth Kelly: I confirm that that is the case.
Mr. Hoban: I am grateful for the Economic Secretary's explanation of the way in which she arrived at the 10 per cent. figure. It sounds as though she has adopted a very pragmatic approach and I appreciate the basis on which the test has been developed because of my experience with quantitative tests of what is or is not strategic. People party to shady agreements may frame if not manipulate them to give an appropriate level of control according to their tax or accounting needs at the time. Therefore, I understand why she decided on a numerical limit.
I am not persuaded, however, that 10 per cent. is necessarily the right number. The Economic Secretary said that there could be situations in which shareholdings of between 5 to 10 per cent. are strategic. As I said in my opening remarks, this is a probing amendment. I am grateful that the hon. Lady put on record the rationale for her decision.
Mr. Field: I was intrigued by the comments of my hon. Friend the Member for Fareham and the Economic Secretary. Will my hon. Friend comment on the fact that the initial consultation exercise suggested that the portfolio holding should be at the level of 30 per cent.? Perhaps that lets the cat out of the bag as to the Government's real intentions.
Mr. Hoban: It is not entirely clear why the Government started off with 30 per cent.
Dawn Primarolo: We have to start somewhere.
Mr. Hoban: I suspect that starting at a higher level allows the Government to retreat graciously to 10 per cent., which they know will gain broad acclaim from the industry. Perhaps that is the explanation for which my hon. Friend was searching, although we did not hear it from the Economic Secretary.
The Government must carefully consider the measure, including the 10 per cent. limit. I hope that those who read the record and who have an interest in the legislation, make further representations on behalf of industry and commerce. I beg to ask leave to withdraw the amendment.
Column Number: 156
Amendment, by leave, withdrawn.
Mr. Flight: I beg to move amendment No. 63, in page 157, line 18, at end insert—
The Chairman: With this it will be convenient to discuss amendment No. 62, in page 157, line 20, after '136', insert
Mr. Flight: These are further technical amendments prompted by the Law Society. Their purpose is to ensure that a share exchange or reorganisation, which would not have otherwise given rise to a disposal for tax purposes, will not result in a period of ownership coming to an end for an entitlement to exemptions on gains from substantial shareholdings. The argument is that it would be incorrect on principle for a period of ownership to be terminated by a share exchange or other reconstruction normally treated as not involving disposal. The amendments are designed to apply when the transaction would have fallen within section 127 of the Taxation of Chargeable Gains Act 1992 but for paragraph (4) of new schedule 7AC to that Act.
Ruth Kelly: The amendments relate to the interaction of substantial shareholdings provisions and the general capital gains freeze for transactions such as share exchanges. Such transactions are complex and the Inland Revenue will publish guidance on the more difficult aspects, particularly as they relate to groups of companies. In this technical area, I shall try to keep matters as simple as possible.
A typical share exchange may arise in a takeover: a company exchanges its shares in the company being taken over for new shares in the acquiring company. For example, company A may hold shares in company B, then company C takes over B and issues its own shares to A in exchange for the shares that A holds in B; A now holds shares in C, which holds shares in B. I apologise to the Committee for going into detail, but it is important for the record.
To avoid company A incurring an immediate tax charge on any capital gain arising from the transaction, it is normally treated as not having disposed of the shares in company B for the purposes of tax on chargeable gains. In the jargon, it is said that the new shares held by A in company C stand in the shoes of the original shares in B. In a substantial shareholdings context however, that general rule would produce a harsh result if the shares held by A and B would have qualified for an exemption but the new shares in C would not qualify for an exemption on a subsequent disposal. In order not to disadvantage A in such circumstances, the general stand-in-shoes provisions are switched off with the result that there is a disposal on takeover. On that disposal, benefits from the substantial shareholdings exemption, and the new shares, will normally have an acquisition cost for capital gains purposes that reflects their market value at the time of the share exchange. In effect, the shares of the company making the takeover—company C in the example—are a completely new holding. The shares in company B
Column Number: 157are treated as having been disposed of. In no sense do the shares in company C stand in the shoes of the original shares of company B. It is therefore right in principle that the holding period for the new shares commences when the investing company receives them on the exchange.
We do not accept that it is reasonable for the investing company to wait 12 months before it can benefit from exemption on the disposal of new shares. That is no different from a situation in which the investing company acquires shares in other circumstances, quite outside a takeover. It would be anomalous if we made an exception in that sort of case. The way that the provision works seems to be consistent with the approach of the capital gains provisions generally and is right in principle. On that basis, I urge the Committee to reject the amendment.
Mr. Flight: Further to that matter—I must confess that I am getting out of my depth—I think that Deloitte and Touche has taken up with the Revenue its diagnosis that paragraph 4 may give rise to an unintended effect in certain circumstances. As set out in the explanatory notes, new schedule 7AC (4) is designed to disapply special stand-in-shoes provisions in certain circumstances. As drafted, the operation seems to result in the stand-in-shoes provisions continuing to apply to a transaction.
I do not want to burn up the Committee's time with full detail, but my secondary point is to ask the Economic Secretary if she is entirely happy that paragraph (4) is correct. If a share exchange or reorganisation would not give rise to disposal for tax purposes, it should not result in a period of new ownership coming to an end for the purposes of the new exemption. It was not clear whether the hon. Lady was agreeing with that principle but objecting to the other potential effects of the amendment.
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