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Finance Bill

June 13, 2005

Finance Bill

I beg to move amendment No. 26, in page 126, line 23. The amendments relate to definitional elements of small and medium-sized businesses. They deal with the proposed Government change to schedule 9 of the Finance Act 1996 which makes an exception if the debtor company is a small or medium-sized enterprise.

It is sensible to break up the amendments into three separate groups, starting with amendments Nos. 21, 22 and 23, which would disapply the exception. In schedule 8, the exclusion in paragraphs 2(3) and 3(6) of small and medium-sized enterprises from the latest interest rules in paragraph 2 of schedule 9 of the 1996 Act presumably acknowledges the fact that the private equity market provides valid support to start-up businesses as well as ailing companies that might otherwise fail. If that is the correct rationale?I am sure that the Minister will confirm that it is?do those rules produce satisfactory results? In our opinion, the definition of small and medium-sized enterprises derives from the annexe to the European Commission’s recommendation in May 2003. The application of that definition to private equities is complex, but in determining which enterprises are being measured we must consider private equity funds and all the investee groups that they control or over which they have significant influence.

Those issues of control and significant influence are at the heart of our concern. The practical implication is that many private equity-backed groups are unlikely to fall within the definition of an SME, regardless of the size of the individual investment. We understand that that is not the Treasury’s intention, but I should be grateful for the Minister’s guidance. In addition, as the definition of a medium-sized company is relatively low, it will not assist the majority of ailing companies, which will be considered large for these purposes. Any unfavourable treatment of such companies would have a significant impact on the available funding and hence the prospects of those companies. I hope that the Minister can explain in detail why the Government have sought that criterion and whether, on balance, they accept that the size of the debtor company should not be a factor in their anti-avoidance proposals.

Amendment No. 26 seeks to allow businesses, whether SMEs or otherwise, to plan carefully. It would prevent their qualification under the provisions from hinging on the vagaries of the currency markets. As the Minister is aware, the definitional thresholds for small and medium sized enterprises are based on euros in the Finance Act 1996, as amended.

As I was pointing out, our proposal would calculate the threshold with reference to sterling. I noted the amusement on the face of the Economic Secretary when mention of the word "euros" brought one of my colleagues to his feet. Many more would have done so, had they been here to play a part in our debate. [Interruption.] That is right?where are they all when one needs them? Doubtless, the proposal would appeal as a matter of principle to some of my hon. Friends who are not here today. I stress, however, that there is no Eurosceptic agenda, although the events of the past week may mean that we are all Eurosceptics now. We all recognise that in the relatively calm currency waters of the past three or four years there have been periods of turbulence that would create unacceptable uncertainty for the most susceptible businesses. That is very much the point that my hon. Friend was making.

I accept that all thresholds are to some extent arbitrary, but at least if currency risk is eliminated from the equation, a company can expand at a controlled rate from year to year and thereby qualify or stand outside the provisions. It is important to remember that small and medium-sized enterprises are often the very businesses that have least exposure to the foreign currency market, so they might find the idea of couching their definition in euros least relevant. Furthermore, such companies are least able to afford uncertainty and are without the internal back-up that would be needed to monitor the currency markets and act accordingly if they were getting near the thresholds. I hope that the Financial Secretary will be able to give us some guidance about why euros are being used, especially at a time when this country has little prospect of joining the single European currency, which may not have been the case when the initial definition was put in place.

Amendments Nos. 24, 25, 28 and 29 seek simply to promote commercial certainty. The Government’s current rules for the relevant accounting period mean that a business may discover that it is not an SME after the relevant period has come to an end. Surely, that cannot be a sensible way to proceed. I accept that we are talking not about an enormous mass of businesses, but about a small number of companies that are getting near the threshold. Inevitably, there are always concerns about thresholds. In relation to certainty, surely it is better to adopt our proposal to refer to the previous accounting period rather than the current one. Let me give as an example a company that is not only worried about the vagaries of the currency market, but potentially reluctant to acquire new business that might take it above the threshold unknowingly in the last few months of its financial year. We always have to keep an eye on the collateral impact of any such proposals.

In conclusion, three factors are at stake. First, there is the question whether the base is in euros or sterling. Secondly, on the notion of a current year valuation, we propose returning to levels in the near past, for certainty’s sake. Finally, we query whether an SME is an appropriate part of the entire criterion. I hope that we can have a sensible discussion on these matters. I know that we will discuss another set of amendments that propose to do something slightly different at a later

Intervention by Adam Afriyie MP

Again, I thank my hon. Friend the Member for Windsor (Adam Afriyie) for his brief contribution. He added some interesting observations about likely fluctuations in the currency market that applied to part of the amendment.

The Minister rightly notes that amendment No. 26 is at the crux of the concerns that we have tried to address. As he says, the exemption of SMEs from a requirement to apply transfer pricing should not be applied across the board where there is an issue of international control. Equally, it is fair to say that in some small subsidiaries of large international groups the issue of control may not be entirely straightforward. We could not necessarily deal with that in an amendment, but it will perhaps be explored in future years, as clearly much of the work that relates to the venture capital industry in various Finance Acts will be subject to continual change as that market matures.

We are concerned, for the reasons that we have set out, about the notion of the standard definition as produced by the European Commission. I accept, from the Minister’s perspective, that there has to be some sort of threshold and that there are rightly tax treatments that make life easier for SMEs but perhaps not for all companies. None the less, it is a somewhat stark distinction, and the uncertainty that we have identified will need to be examined in future years.

There has been significant lobbying by the venture capital industry, which has expressed certain concerns, but we have had a chance to articulate them during the debate. On the basis of the replies that we have had, I hope that we will be able to return to this in due course, particularly if it is found that there are ongoing problems in the venture capital and private equity industries, which are so important to this country, and that the Minister will be open-minded about that. With that in mind, I am happy at this juncture to beg to ask leave to withdraw the amendment.

Amendment No. 20 would render the entire previous debate redundant, as it seeks not to make any amendments at all to schedule 9 of the Finance Act 1996. It might have been easier had we had that debate initially.

Sufficient complications still surround collective investment schemes and plague the venture capital industry. We accept that changes to their tax treatment have largely come about as a result of fierce lobbying by those involved in the industry and many of those are to be welcomed. However, there is a strong view in the marketplace that some of the proposals concerning transfer pricing and loan relationships may reduce the number of private equity deals being done in the UK. As my hon. Friends the Members for Runnymede and Weybridge (Mr. Hammond) and for Chipping Barnet (Mrs. Villiers) said during the debate on the whole issue of transfer pricing, innovation, flexibility and commercial certainty must be the imperatives, and we fear that the Treasury’s real motivation is to increase tax take to overcome an increasingly unmanageable black hole in finances.

As ever, it is the unintended consequences that we must ward against. In particular, the proposal to collect an increased share of tax, sooner rather than later, on a crude interest may reduce the volume of private equity deals in the UK. Ultimately, as is the difficulty with all such matters, we will not know the truth until it is too late. However, we are also convinced that there is a fear that the proposal will reduce the UK tax take and we need to remember that the venture capital industry does not invest only in tremendously successful industries and that its returns are by no means always the sure thing of tabloid legend. Indeed, private equity plays an important and full part in resuscitating?or at least attempting to resuscitate?ailing businesses. There is a genuine sense of foreboding that the plans might inadvertently boost the rate of business failures in the UK.

We support the current arrangement whereby tax is deductible from interest payments that are payable when the private equity investor sells the investment on. Such schemes will typically last four or five years. Some last for a shorter time but, as a rule of thumb, four or five years is a useful benchmark. The tax deductions for the interest charge arise when it accrues in the accounts, not when such interest is paid. It is clear from the Government’s proposals that they regard that as something of a loophole, notwithstanding the established agreement between the venture capital industry and the Inland Revenue, which was brokered as recently as the Finance Act 2004. It covers a wider range of investment vehicles, which could lend to borrowers, and the borrower could still obtain a tax deduction for late paid interest.

Our concern is that the risk will have an adverse impact on the pricing of many private equity transactions, to the potential detriment of UK business. As the Financial Secretary understands, the private equity business is still, even by British standards, a fledgling business, but is emerging strongly in many other parts of the world. Ten years ago, Australia had no private equity business to speak of but is now a significant competitor.
It is very much a global market and we fear that the Government’s proposal would restrict the borrowing company to claiming group relief against the profits of only a single year?the final year of the scheme. That may cause difficulties. If the interest deductions are all delayed until the interest is paid rather than eked out over the period of a scheme, there will be only one substantial tax deduction. Clearly, there is then a risk that the aggregate interest would be more than the overall profit in that final year.

We must always remember that the profitability of any company may be cyclical for a host of reasons for the duration of the scheme. Those reasons may go to the heart of the nature of the business. Perhaps the business is growing and looking to grow more, thus having less of a profit in the final year under venture capitalists. Profitability may also be cyclical simply for general economic reasons. If total interest exceeds profits in the final year, the borrowing company runs the risk of some its accrued interest payments having zero economic value, even when there can be no reasonable suggestion of the scheme having been created deliberately or artificially to avoid tax.

In practice, the excess interest deduction may prove hard to use and undermine the profitability of the proposed scheme. Our difficulty is that, if the profitability of a proposed scheme is undermined, in a global market for private equity, more deals will leave these shores. The probable result of that is a lower tax take. Nothing would be worse than trying to ensure a bigger slice of a much smaller cake. I appreciate that that is the perennial problem of Treasuries through the years.

The other amendments in the group are all consequential. I hope that the Financial Secretary will provide at least some guidance about our proposals and whether there is any way in which we can try to ensure that some of the more negative consequences to which I referred are put to bed.

The Minister will be glad to know that the Opposition will withdraw the amendments. In part, they were probing amendments. It was important to have some discussion about whether small and medium-sized enterprise distinctions should be made at all within the context of the Minister’s proposals.

We are rightly proud of the strength that the UK has in our private equity business. It is particularly important that that is maintained, not least given the strength of the two great economic superpowers of the future?China and India?and our links with those countries. Inevitably, there will be a significant role for a number of joint ventures. Much venture capital will find its way in various different guises either in the UK or beyond that. It is therefore important that the pre-eminence of our private equity business is seen to be maintained.

Clearly, the Opposition are being lobbied, just as the Government are lobbied, and, inevitably, the Armageddon and appalling outcomes that are sometimes presented can be exaggerated. Equally, my hon. Friend the Member for Chipping Barnet (Mrs. Villiers) rightly articulated one of the Opposition’s concerns when she referred to the notion of such overseas arrangements being somehow nefarious and having complicated structures, which is an inevitable part of that sort of transaction.

I have some understanding that the Treasury wishes, as the Minister rightly puts it, to anticipate new avoidance arrangements Inevitably, the best tax lawyers and tax structurers are likely to be one or two steps ahead of the game, so it is legitimate for the Revenue and the Treasury to try to have such an understanding. Certainly, it surprised me when the Minister said that the proposed revenue gain was as little as £5 million, which is very much small fry. None the less, one hopes that, if there is to be a genuine move towards anticipation of new avoidance arrangements, there will also be a recognition that it is wrong?we will no doubt discuss this in greater detail in Committee in the next two weeks?for any of this legislation to be retrospective or retroactive. If there is to be a policy from the Treasury to anticipate avoidance arrangements, surely it is part and parcel of that, and fair game, to ensure that retroactivity and retrospection is kept to an absolute minimum?nil from the Opposition’s perspective.

We have had a reasonably amicable, albeit shortish debate on this matter. Again, the Liberal Democrats?the real opposition?have not sought to make any contribution, which is a matter of some surprise. Silence is golden?or perhaps orange.

We shall not press the matter to a vote. I beg to ask leave to withdraw the amendment.