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Mr. Edward Davey: One of the arguments behind our arrangement is that shares are inherently risky. As we have seen in the high-tech industry, they are volatile and as likely to go down as up. That gives a great justification for taxing at the point of granting rather than at the point of exercising. Will the Minister reflect further on that point? Mr. Timms: No. The hon. Gentleman is wrong. One of the criticisms of the old arrangement was that one paid national insurance on the basis of the value of the option at grant. If the shares subsequently declined in value, one paid national insurance on the basis of the higher value. The hon. Gentleman makes a telling point, but the matter works in the opposite direction to the one that he suggested. The liability now applies, as income tax has always applied, at the point of exercise. The tax is applied at the right point-the one at which the employee has a potential benefit from the option. That was not the case when national insurance applied at grant. Mr. Flight: With respect, it is not correct to assert that option schemes were widely or even significantly used as an alternative to bonuses. Option schemes and bonuses are clearly quite different in their nature, their time periods and their risk on equities. The typical arrangements involve both bonus and option arrangements. I suspect that the motivation behind what is proposed may be linked to a wrong diagnosis by the Revenue. The reason for the old arrangement was practical. It was logical, because sometimes when the options were granted they had a market value. It was not unreasonable for the NIC to apply to that, and for individuals to take their risk then as to whether their income tax liability would go up or down.
11.15 amMr. Timms: On that last point, the hon. Gentleman argued that liability should reflect the actual benefit, which is what is achieved by applying the liability at exercise rather than at grant. I do not agree with the hon. Gentleman's suggestion. He did not actually say that avoidance by the route in question did not happen. It is certain that it did. The difference between us lies in our views as to whether that was a significant problem that needed to be dealt with by the Government. Our view is that it was. One company alone avoided £25 million by the device, and there were probably about 50 relevant cases. No doubt there would have been more. Mr. Letwin: Does not the Financial Secretary agree that there is something odd in what we are discussing? A person who invests capital in one of the relevant start-ups-and who invests it in the form of options-ends up by paying a capital gains tax rate of 40 per cent. His fellow, who invests labour, ends up paying a capital gains tax rate on the same options of 47.3 per cent. Why favour capital rather than labour? Mr. Timms: The rate paid by someone who invested would depend on when the shares were sold. Such individuals would be able to exercise their options and continue to own the shares and then benefit subsequently from the changes to capital gains tax under the Bill, with the rapid tapering down to a 10 per cent. rate in due course. That benefit would be available to any people who had exercised their options and hung on to their shares. Mr. Letwin: The Financial Secretary is right, of course. Let us suppose that the parties in my example have exercised the same options at the same rate. Both might from then on experience capital gain and would benefit-I put heavy inverted commas round that word-from the usually complicated taper relief. Heaven knows whether a business asset or a non-business asset would be involved. They would be all square with one another. The labourer and the capitalist would be taxed in the same way. However, at the moment of the crystallisation-when the exercise of the option occurred-one would be taxed at 40 per cent. and the other at 47.3 per cent. I had thought that that was a quirk. I mistakenly assumed that it involved the upper earnings limit and that it did not matter. However, we are dealing with a straight difference between 40 per cent. and 47.3 per cent. I simply cannot see the justification for it. I am worried by the fact that the hon. Member for Kingston and Surbiton looks puzzled. Perhaps I have made another error. However, if I am right about the effects that I have identified, the case is an odd one. Mr. Timms: I do not think that it is. People who have worked in the company, of course, have not invested capital. That is the point. They invest capital only at the moment when they exercise the option, not before. What the hon. Gentleman has pointed out is not an irregularity. Mr. Letwin: Will the Financial Secretary give way? Mr. Timms: I will in a moment, when I have made this point. Everyone's labour is subject to income tax and national insurance. The employer has a national insurance liability as well. We want to ensure that those liabilities are incurred by those who are being paid a wage and those who benefit through share options. Mr. Letwin: I am grateful; the Financial Secretary is patient in giving way again. However, I persist in saying that he is not addressing the issue. We all accept the difference between paid labour and risk capital. The maximum tax rate on paid labour is 40 per cent. and the employer pays employer's NICs. However, we are not dealing with ordinary paid labour. We are dealing with risk. People can risk either their capital or their labour. A person who receives no remuneration but who receives share options will have risked his labour. He does not know whether he will be paid anything, because he will not know, until he exercises the option, whether the shares will have a value. The Chairman: Order. I assume that the hon. Gentleman is making an intervention, not a speech. Mr. Letwin: You are absolutely right, Mr. Cook. I shall try quickly to bring it to a conclusion. The fact is that either labour or capital is at risk. Why should one be taxed at 47 per cent. and the other at only 40 per cent? Mr. Timms: The hon. Gentleman speaks of risk labour, a concept that was introduced by the hon. Member for Arundel and South Downs in a sedentary intervention. He seems to suggest that it should be taxed as though it was risk capital. We want to ensure a level playing field between the various forms of remuneration that people receive for their labour. I believe that we have the right balance. Mr. Edward Davey rose-
Mr. Timms: I should make some headway. I hope that we have dealt with the misunderstanding about the 59 per cent. Mr. Letwin: Yes. Mr. Timms: The top income tax rate in the major EU countries-France, Germany, the Netherlands, Spain and Sweden-is more than 47.3 per cent. In the US, an employee living in California pays a top rate of more than 45 per cent., and someone living in New York City would pay more than 46 per cent. I want to respond to the comparison made by the hon. Member for Kingston and Surbiton with US tax rates. In general, the US taxes such gains in exactly the same way as the UK. The gain made to the date of exercise is chargeable to income tax, and gains made subsequent to that and before the date of sale are chargeable to capital gains tax. On unapproved US options, the gain made to the date of exercise is liable to income tax, with a top rate of 39.6 per cent.-plus state taxes, and plus the employer's Medicare liability, which is comparable to employer's NICs although at a lower level. The subsequent gain on sale of those shares is liable to income tax if the shares are held for less than a year-this may be the hon. Gentleman's query-and 20 per cent. capital gains tax if held for more than a year. In the UK, if the shares are held for more than four years, the rate of capital gains tax will apply at 10 per cent. The arrangements for approved options are rather different. I believe that, in full comparison with the US, once the changes are made our rates will be competitive with those faced by many employees in the US. Mr. Davey: The Financial Secretary seemed to confirm my understanding that, after a year, unapproved share options in the US come under the capital gains tax regime whereas in the UK they will still come under the income tax regime. That is why the differentials in tax rates arise, which is why it is a fair comparison between 47.32 per cent. and 26 per cent. Will the Minister confirm that? If so, it is a major problem, which the new clause does not solve. Mr. Timms: The point is that when unapproved share options in the US are exercised- It being twenty-five minutes past Eleven o'clock, The Chairman adjourned the Committee without Question put, pursuant to the Standing Order.
Cook, Mr. Frank (Chairman) Allen, Mr. Best, Mr. Burnett, Mr. Casale, Mr. Cawsey, Mr. Clapham, Mr. Coaker, Mr. Davey, Mr. Edward Dorrell, Mr. Faber, Mr. Flight, Mr. Gardiner, Mr. Healey, Mr. Heathcoat-Amory, Mr. Johnson, Miss Melanie Kemp, Mr. Lawrence, Mrs Letwin, Mr. Ottaway, Mr. Palmer, Dr. Pond, Mr. Primarolo, Dawn Rammell, Mr. Ryan, Joan St. Aubyn, Mr. Simpson, Mr. Keith Timms, Mr. Tynan, Mr. Tyrie, Mr. Winterton, Ms Rosie
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| Prepared 29 June 2000 | |
