Taxation – What a tangled web

I am sure the prime minister means it when he says he wants to encourage enterprise and wealth creation. Like the last government, he realises wealth creation is better left in the hands of entrepreneurs than government, and what entrepreneurs really need are low, stable interest rates, low, stable inflation and a stable currency.

They also, however, benefit from regulations they can understand, at least with the benefit of professional advice. Nowhere is this more evident than in tax regulation where the government introduces legislation of such complexity it gets tripped up itself.

Let me give you a recent example. Last year, the government introduced a number of anti-avoidance measures designed to prevent shares being issued to employees where the value of the shares was restricted by various conditions. This was essentially intended to restore the position to that which the Inland Revenue had thought existed before obtaining legal advice to the contrary.

The sets of measures were introduced as ICTA 1988 section 140A to section 140C. At the same time, the government recognised conditions were frequently imposed on shares for genuine commercial reasons which should be exempted from the legislation.

This would typically apply where somebody was granted the opportunity to acquire shares in a company but with the condition that the shares would have to be forfeited in the event of the employee leaving – sometimes referred to as ‘good leaver-bad leaver’ clauses.

The legislation introduced last year provided an exemption for employees who were issued shares subject only to that restriction. Unfortunately, nobody at the time seemed to realise that many commercial operations are organised as groups.

Would the exemption apply to an employee of a subsidiary company who was issued shares in the parent company, where this commercial restriction applied in the event of leaving employment?

Some time after the Finance Act last year, the Revenue was asked how it intended to interpret these rules. Unfortunately, its answer meant the employee in a subsidiary was potentially in a worse position than the senior executive working for the parent company – hardly the intention of the legislation.

Taking up the challenge, the English ICA and the Chartered Institute of Taxation lobbied for this anomaly to be corrected and the government duly responded to their efforts with clause 40 in this year’s Finance Bill.

Great stuff, the government admits it got it wrong and is prepared to put it right.

However, this is where the error was compounded because clause 40, as drafted in the Finance Bill, only comes into effect on the day of royal assent so all those employees of subsidiaries who have received shares during the last year are still caught by a set of rules which everybody admits were badly drafted.

Never mind, we still have the opportunity to put things right at the standing committee debates, a challenge taken up by opposition member Nick Gibb on 20 May.

He suggested the correction should have taken effect from 17 March 1998 or that the government should at least, ‘make a statement that the measures would in practice be applied on that basis’. Either of these moves would have put the matter straight.

The response by the economic secretary to the Treasury, Patricia Hewitt, was unexpected. ‘Amendment number 108 will change the tax treatment of employees who have already received shares in the expectation that they would be subject to the special tax rules,’ she said, with the result being that the amendment did not proceed.

This was clear nonsense. We had legislation which all parties to the debate knew was flawed and was being corrected. Nevertheless, a group of employees of subsidiary companies, who happened to receive their shares in the critical intervening period, were now set to be penalised.

Picture a fairly typical high-growth entrepreneurial business which is seeking a float on the stock market with shares issued in this form. With shares about to become marketable, it might be the company itself which suffers the PAYE and national insurance cost and, in many cases, that could be considerable.

Fortunately, there was a happy ending. There was further lobbying by various firms of accountants and a helpful intervention by MP Howard Flight.

‘We are glad that the government is correcting the error in clause 40,’ he said. ‘However, does it intend the Revenue to be lumbered with the unintended law for a year, or will the Revenue operate as if the mistake had not happened?’ Under pressure in this debate on 6 July, Hewitt finally succumbed to the amendment.

I am not sure how much effort was involved in all of this, but it all arose because last year’s draftsmen used the word ‘company’ when they should have used ‘group’. Entrepreneurs and their professional advisers have been left in a position of uncertainty.

The root cause of all this is the complexity in our legislation. Powerful minds in the Treasury, government and the professions are straining to understand what all this means and in the hope that the people who really matter can get on with the job they know best.

This complex process and misapplication of people’s time is what my late colleague Philip Hardman used to call ‘a national disgrace’.

There is certainly more openness and debate, but the root problem of complex regulation, in tax and other matters, will stifle our entrepreneurial spirit if we do not tackle the problem head on.

Mike Warburton is a tax partner at Grant Thornton.

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