§ (1) Where a body corporate's standard profits for a full year fall to be calculated by reference to its profits during the standard years then—
- (a) if the average amount of its borrowed money in the chargeable accounting period exceeds the average amount of its borrowed money during the standard years, its standard profits for a full year shall be increased by an amount equal to four per cent. of the difference; and
- (b) if the average amount of its borrowed money in the chargeable accounting period is less than the average amount of its borrowed money during the standard years, its standard profits for a full year shall be decreased by an amount equal to four per cent. of the difference:
§ Provided that where the body corporate makes an election under paragraph (a) of subsection (4) of section thirty-three of this Act paragraphs (a) and (b) of this subsection shall have effect as if it had had no borrowed money during the year specified in the election.
§ (2) Where a body corporate's standard profits for a full year fall to be calculated 1232 otherwise than by reference to its profits during the standard years, its standard profits for a full year shall be increased by an amount equal to four per cent. of the average amount of its borrowed money in the cheargeable accounting period:
§ Provided that this subsection shall not apply to any chargeable accounting period for which an election under section thirty-five of this Act has effect as respects the body corporate.—[Mr. Boyd-Carpenter.]
§ Brought up, and read the First time.
§ Mr. Boyd-Carpenter
I beg to move, "That the Clause be read a Second time."
This is the first of the new Clauses in the name of my right hon. Friend the Chancellor. It carries out the undertaking which he gave a week ago to insert a provision in the Bill to provide—for E.P.L. purposes—for the position of borrowed money. As the tax was introduced there was no such provision. The reason why, on consideration, it was thought desirable to introduce this provision was described briefly by my right hon. Friend a week ago.
The purpose of the Clause is to provide that where standard profits are to be calculated by reference to profits during 1233 the standard years, borrowed money shall be taken into account by adding a figure to the standard of the rate of interest actually paid plus 4 per cent. A similar provision is made under subsection (2) of the new Clause, where the calculation is based either on nominal capital or on the net assets standard.
These changes provide, in particular, for the case where debenture capital has been raised, as it has been on a substantial scale by a good many companies during recent years. Simply for purposes of comparison it might interest hon. Members to note what was done on this subject under the wartime Excess Profits Tax. There, allowance was also made for borrowed money, but a slightly different formula was adopted. In that case the amount of interest paid was deducted from a maximum of 8 per cent. and the resultant figure was the allowance for Excess Profits Tax purposes. It was the same formula that we are applying, but in reverse.
That is the effect of the Clause, and the only other matter which arises is whether this is the correct percentage of addition. It was because there are Amendments down that I thought it convenient to move the Clause at this stage.
§ 7.30 p.m.
§ Mr. Roy Jenkins
We have some Amendments on the Order Paper, Colonel Gomme-Duncan. I do not know whether it is your intention to call them and whether we shall have the main debate on the Amendments, or not.
§ The Temporary Chairman (Colonel Gomme-Duncan)
It is proposed to call the Amendments, but of course the decision on the Clause must be reached before we can amend it.
§ Clause read a Second time.
§ Mr. Jenkins
I beg to move, as an Amendment to the proposed Clause, in line 6, to leave out "four," and to insert "two."
§ The Temporary Chairman
Before we begin the discussion, may I suggest that it would be for the convenience of the Committee if the three Amendments on the new Clause—all similar—were taken together.
§ Mr. Jenkins
This is one of the concessions which the Chancellor made as part of a great batch of concessions placed on the Order Paper a week or so ago, and it is one of the few which we think go rather too far. The provision is that where a company borrows new money, or has been operating on something other than profits actually earned, where its borrowed capital is part of the structure, then this company, in arriving at its standard profits, should be able not only to deduct the cost of servicing the loan capital, however high it may be, but also to deduct an additional 4 per cent. over and above that.
That seems an excessively generous provision. There can be no conceivable obligation upon a company to pay to its debenture holders, or to those who hold an unsecured note issued by it, any sum greater than that covered by the rate of interest of the debenture or the unsecured note. That is already fully covered, without this special provision for an additional 4 per cent.
What is the basis of giving the 4 per cent. concession? Is it to enable a company to make some provision for redeeming the loan capital which is raised in this way? If so, that seems a rather doubtful proposition, because what it means in effect is that a company which raises loan capital will be allowed to meet that capital, as far as E.P.L. is concerned, out of tax-free profits and to build up the assets which belong to the ordinary shareholders out of tax free profits, as far as E.P.L. is concerned.
As far as our general taxation provisions are concerned, it is obviously the case that, out of taxed profits, companies apply a great part of their profits to redeeming prior charges or building up the business in other ways. In that way, out of taxed profits, the value of the holdings of the ordinary shareholder is substantially increased. What we are providing for here, however, is a situation in which companies are entitled to do that out of tax-free profits as far as E.P.L. is concerned, and there does not seem any good reason for such a principle.
Further, it may benefit a company to have raised loan capital in the past instead of ordinary share capital. Suppose we take the case of a company which, some time ago, brought into its capital 1235 structure debentures bearing a very high rate of interest—a 7 per cent. debenture, not a very usual thing but one which might not be altogether unknown in certain circumstances in a very doubtful company. That company, which will get 7 per cent. in the normal way for servicing the debenture, will get an allowance of another 4 per cent. under the new Clause, whatever its capital structure, making a total of 11 per cent. by virtue of the capital raised by means of that debenture. Yet if it were dependent upon a capital standard and not upon either a net asset standard or a standard based on profits actually earned, it would get only 10 per cent. on capital raised by means of ordinary share capital.
That seems to me an entirely anomalous position—that it may have paid a company better in the past to have raised money by means of issuing a debenture rather than by means of issuing ordinary share capital. It is conceivable in certain companies that this may even apply in the future. I am aware that ordinary share capital raised in the future will raise the profit standard of the company not by 10 per cent. but by 12 per cent.
We do not know how far the Government intend to go in the direction of dearer money, although we had a lot of discussion about that on an earlier Clause. Certainly they gave no indication then, nor is there any indication in the present situation, that they have yet achieved their objective by the policy of dearer money, as far as it has gone, or that they will not need to go further in this direction. If they do go further in this direction, it may be that companies which, by their nature, are not of very high credit standing, will have to pay very high rates of interest indeed on loan capital which they raise. If in one or two exceptional cases it were to get to 8 per cent., companies would be doing better and existing ordinary shareholders would be doing better to raise their new capital by means of issuing loan capital instead of ordinary share capital, or, even, of ploughing capital back into the business.
It is highly undesirable that any such possibility should arise, but if there were a case of a company which had to pay a very high rate of interest on loan capital, 1236 that could well be the situation. Suppose a company had to choose between raising equity capital and raising loan capital bearing a rate of interest of about 8 per cent. If it chose the former and raised equity capital, it would let new people in from outside to share in the interests of the existing shareholders. Whatever dividend is paid on the ordinary shares, then by however much the 12 per cent. exceeds that, the amount to which that enables money to be put back belongs to the new ordinary shareholders rather than the previous ordinary shareholders.
If, on the other hand, the company decides to raise money by loan capital, the only thing which will belong to the new debenture holders will be the interest which they will receive. and the additional profits standard, which will let rather more money be ploughed back, will go to swell the value of the holding of the existing ordinary shareholders. I see a certain danger if the policy of dearer money were to be pushed further than it has been pushed at present. This generous provision might have the unfortunate effect of encouraging companies to raise new capital in the form of debentures or other loans rather than in the form of share capital.
It is undesirable that that should be encouraged. It is undesirable that one should give companies fiscal inducements—and this was one of the difficulties about the Profits Tax under the late Government—to have a highly geared capital structure. It is desirable to encourage them to have a low-geared capital structure—to have a lot of ordinary share capital and not to have a great pyramid of loan capital. I am afraid that this generous provision may go too far to encourage that undesirable result.
My hon. Friends and myself have put down an Amendment to reduce the amount to 2 per cent. We did not oppose the Second Reading of the new Clause because as we have shown from previous speeches, we believe strongly in the heavy taxation of company profits, although we regard the method of doing it by E.P.L. as a very bad one. Therefore, we upon this side of the Committee look with great favour upon all the proposals which the Chancellor has brought forward at a very late stage to alleviate the very damaging effects of the E.P.L., but in this case it 1237 does seem that he has been a little unnecessarily generous.
We feel that, perhaps, there is some case for giving a company which has raised or is raising loan capital a certain amount of allowance beyond the mere rate of interest, but 4 per cent. does seem to us to be an over-generous provision; it seems to us to be one which may encourage companies to raise loan capital rather than ordinary share capital in certain circumstances. Therefore, we feel that the Chancellor may save a small amount of the revenue which he is giving away by his concessions by this 2 per cent. We feel that our proposal is very unlikely to have any deleterious effects, and we hope that the Government will seriously consider the Amendment.
§ Mr. Crosland
Like my hon. Friend, I should like to go into this question in rather more detail than did the Financial Secretary. I am not making any complaint against him on that ground, because he could not know how much interest this Clause was going to arouse.
§ Mr. Boyd-Carpenter
The hon. Gentleman will forgive me, but if he had been in his place at the time when I moved the Second Reading of the new Clause he would have appreciated that I did indicate that there were Amendments down, and that I would reserve my observations on them until they were moved. I was not discourteous, but was only waiting to hear the arguments for the Amendments before answering them.
§ Mr. Crosland
I certainly did not intend to suggest that there was any discourtesy on the hon. Gentleman's part, for he has been consistently courteous throughout the Committee stage.
This new Clause is the result of a great deal of pressure on the Government; indeed, the failure to make some provision of this sort was one of the points about the original proposals for the levy which were picked on for most discussion in the economic and financial Press, and the argument put forward. I want to go into it in some detail, because I think it is an important point. The argument put forward was this, that a company, broadly speaking, had two alternative methods of raising money: it might raise it by an issue of share capital, or it might raise it by borrowing.
1238 If we take the case of a company wishing to raise £100,000 of new money, it may either raise it through the issue of 5 per cent. debentures, or it may go to the market with a new issue of ordinary shares. The argument was that if the company raised the new money by means of 5 per cent. debentures, it was then allowed only 5 per cent. on that £100,000 before E.P.L. first became payable.
If, on the other hand, it raised the new money by means of an issue of share capital, it was then, under the original provisions, allowed 10 per cent. on that £100,000 before it became liable to E.P.L., and in one of the Chancellor's later Amendments it is now allowed 12 per cent. on that without E.P.L. liability. The argument was that this was a very unfair disparity, between merely being allowed the rate of interest, 5 per cent. in the one case, and in the other case being allowed 10 per cent., as originally it was, and 12 per cent. as it now is. The argument was that this disparity was unfair and had no justification on any grounds of economics or anything else.
I want to suggest that much of the argument on this point was in fact highly misleading—much more misleading, I think, than my hon. Friend the Member for Stechford (Mr. Roy Jenkins) made out in his speech, because clearly the 5 per cent. interest payable on those debentures could be offset by the company against Profits Tax, whereas the 10 per cent. or 12 per cent. allowed on any share capital before becoming liable to E.P.L. naturally was subject to the Profits Tax. If we bring in the factor of Profits Tax, the discrepancy between the two figures is nothing like as great as appears at first sight.
Suppose there was a full distribution—I am taking the extreme limiting case here—suppose a full distribution with nothing put to reserves, the 10 per cent. that is allowable on share capital before E.P.L. becomes payable then in fact becomes, at the new Profits Tax rate of 22½ per cent., 6.9 per cent.—once Profits Tax has been paid, assuming a full distribution, and even with that 12 per cent., once Profits Tax has been paid on a full distribution, the figure allowed before E.P.L. becomes payable is then reduced effectively to 8.3 per cent, and so it is clear, once we take into account the factor of Profits Tax, and the contrast between what is allowable 1239 in the case of debentures, namely, a mere 5 per cent., and what is allowable in the case of share capital, namely, 10 per cent. originally but 12 per cent. on new issues—once we take Profits Tax into account this disparity becomes very much less than appears at first sight.
Surely it is right and reasonable that there should be a substantial disparity between the percentage allowed for E.P.L. purposes on borrowed money, on the one hand, and of share capital on the other hand. This seems to me perfectly logical and perfectly sensible—that there should be a disparity, because, after all, the borrowed money costs very much less to raise than the issue of new share capital. In the case which I have taken by way of illustration, the £100,000 obtained by a new issue of debentures only costs the rate of interest of 5 per cent., whereas a similar sum of money raised by a new issue of share capital, of course, would cost effectively very much more to raise—for perfectly obvious and sensible reasons.
What is the excess that we are interested in when we are considering this matter? It is surely the excess over the essential cost to the company—or the prospective cost to the company—of raising this extra £100,000 of money; and the plain fact is that the effective cost to the company is much greater in the case of the issue of new share capital than it is in the case of borrowing to the same amount; and this is particularly so today, with yields as high as they are now—obviously very much higher than they were a year ago. So this is particularly true at the present moment.
The new Clause comes very near to eliminating completely this gap between what is allowed in respect of borrowed money and what is allowed in respect of new issues of share capital. In the case I took, the case of 5 per cent. debentures. 5 per cent. actual rate of interest on the debentures plus an additional 4 per cent.—the figure laid down in this Clause—is now allowed so far as those debentures are concerned, but if we take the case of share capital, and allowing the company makes a full distribution, and allowing also for the fact that Profits Tax has now been raised to 22½ per cent., this cost—this 9 per cent. which is allowed for de- 1240 bentures—comes to more than the 12 per cent. which is allowed on the new issue of share capital, once we take the distributed Profits Tax into account. In fact, the 9 per cent. allowed on debenture compares with 8.3 per cent. when once we take Profits Tax into account, and this seems to me—and this is the point which my hon. Friend did make, though not, as I say, strongly enough—really an absurdity—that the allowance in respect of borrowed money is actually greater now in many cases than the allowance in respect of a new issue of share capital.
We realise that there is a case for allowing a company for the purposes of E.P.L. something over and above the actual rates of interest it has to pay on borrowed money. It may be reasonable to say it should make some net profits on that borrowed money which it is using before it becomes liable to E.P.L.—over and above the rate of interest it has to pay. That may be a perfectly reasonable case.
It may be reasonable to say that before it becomes liable to levy it should be allowed to make some provision for repayment of the borrowed money. But we think, in view of the considerations that I have given, that 4 per cent. goes very much too far, and that is why we put forward this Amendment to reduce the figure of 4 per cent. to 2 per cent. We believe that this figure will be adequate for the legitimate purposes for which it is required and that 4 per cent. is undoubtedly very much too high.
The real argument which I have been trying to make is that if we accept the figure of 4 per cent., it then weighs the scales too heavily against a company which wants to raise new equity capital and in favour of doing so by borrowing—the issue of debentures, unsecured loans and so on; and it weighs the scales too heavily against the issue of new equity capital. I agree that there is a case for saying that the effects of taxation over the last few years have been to discriminate too strongly against the issue of new capital.
We take the view that so far as discrimination already exists because of the effects of Profits Tax, nothing should be done under levy which makes it worse. It is for that reason that we wish to reduce the temptation to companies wishing to raise new capital to do so by borrowing and not to do so by the issue of new 1241 equity capital. Because we want to reduce that temptation, we are moving this Amendment that 4 per cent. should be 2 per cent.
§ Mr. Grimond
There is, I think, general agreement in the Committee that some such new Clause as this is necessary. The argument turns on the amount, whether it should be 4 per cent. or 2 per cent. I must say that I share the views of the hon. Member for Gloucestershire, South (Mr. Crosland) that it is very undesirable to encourage the raising of capital by debentures or fixed charges rather than by the issue of equity shares.
On the other hand, I think that we have to realise that this new Clause will affect not only capital raised now or in the future but affects the company which has already raised capital. In the years which it will cover, a great deal of capital has been raised by debentures, not so much because a company wanted to do that, but because it was encouraged to do so.
I think, too, that it has often been a developing company which has found it easier to raise capital by way of debentures than by a new issue. Personally, I am not convinced by the argument put forward in favour of this Amendment. I believe that if we say that 4 per cent. is too high for the reasons which have been given, we shall be leaving out of account that much of this money has really been raised for the same purpose as if it was equity capital, and it is not fair to say that really all a company which raises capital by debentures wants is to be able to earn enough with that money to be able to pay interest on the debentures and create a sinking fund. I do not think that is always sufficient.
It requires also to earn enough with that money to build up reserves in business and to enable it to supply itself with working capital and with capital in general. Therefore, it should be entitled to some considerable amelioration of the terms of the levy, such as is given by this new Clause. We have to bear in mind when considering this matter at every stage that companies today are not free agents. They have been affected again and again by changes in the economic situation, or changes in the financial 1242 policy of the Government which are entirely outside their control. A great many companies are going to be affected, for instance, by devaluation when it comes to assessing them for liability under this levy or by the activities of the new Issues Committee, and so on.
I hope that the Financial Secretary will be able to give at least some indication of his views about the future. I hope he will say that it is not desirable to make companies conform to some capital structure imposed upon them, and that as far as possible the policy of the present Government will be to try and avoid interference with their normal growth.
I also hope that he will give us some financial reason for the justification of this figure of 4 per cent. Personally, I should not like to do so. I do not know why 4 per cent. was chosen. But I feel that in this Committee the financial reasons for this levy, if there are any good financial reasons, have not been stressed sufficiently. Moral reasons and reasons based on the fulfilment of pledges have been stressed. But after all this, the country, as I think we all agree, is in a very serious financial state.
If the Government are going to bring in proposals in the Finance Bill, they ought to be justified with reference to the economic state of the country and not merely to fulfil electoral pledges that may have been given. If it is necessary to break electoral pledges I am sure that the Government would accept the proposition that they should do so if it is in the interests of the country. I hope that the Financial Secretary will tell us why 4 per cent. was chosen. I certainly think that 4 per cent. is not an excessive figure. I think, however, that the Amendment will have served a very useful purpose if it encourages the Government to tell us why they chose this particular figure.
§ Mr. Boyd-Carpenter
I think that in this sort of case the precise figure one favours is a matter of judgment and of forming one's view of what seems to be in substance the rate at which to fix the figure; and it is, therefore, a matter upon which legitimate opinions can differ. I think there was great force in what the hon. Member for Orkney and Shetland (Mr. Grimond) said as to the undesirability of forcing companies to adopt a 1243 capital structure other than that which, in their own judgment of their own needs, they approve. I think that is a consideration which is rather material to this Amendment, as well as an extremely sound principle.
The hon. Member for Stechford (Mr. Roy Jenkins), in moving this Amendment, gave us his view that we were overgenerous in the fixing of this particular figure. In view of criticisms on other parts of this tax as to lack of generosity, there was a certain refreshing novelty in that criticism; but it is, of course, a fact that when looking at this problem it is much a matter of opinion whether 4 per cent. is over-generous or not. I am bound to say that I see no evidence of what the hon. Member suggested. I will come to the reasons in a moment. Perhaps I may, first of all, comment on some of the figures which the hon. Member for Gloucestershire, South (Mr. Crosland) adduced in supporting the Amendment.
So far as I could follow him—the hon. Member will himself appreciate the difficulties sometimes in following figures in an argument across the Floor of the Committee—the figures were based on the assumption that all the profits earned as a result of the borrowing of this money would be distributed. I think that is the basis of his calculation.
§ Mr. Crosland indicated assent.
§ Mr. Boyd-Carpenter
I am glad to see that the hon. Member confirms that. That being so, it would seem to me somewhat to invalidate the conclusions he based on it. It certainly would not be the experience of most hon. Members that companies which raised loan capital promptly distributed all the profits made as a result of the use of that loan capital. It would be, in most cases, a most unwise and improvident thing for them to do, from every point of view, and I do not think that we need necessarily concern ourselves very much with the effect of these extreme cases. We have to concern ourselves much more with the general effect in the generality of cases. What we have to do there is to try to keep a fairly even balance between an excessive encouragement and an excessive discouragement to use loan capital.
1244 8.0 p.m.
I was interested to note one thing about the Amendment of the hon. Member for Stechford. He tabled the Amendment to reduce the figure from 4 to 2 per cent. at a time when the figure in the Bill for new capital or profits ploughed back was 10 per cent. It was subsequent to his tabling of the Amendment that my right hon. Friend brought forward the proposals which raised the figure to 12 per cent. Therefore, some of the force of his argument as to the relationship between the figures for loan capital and profits ploughed back and new ordinary capital has been diminished by the change which my right hon. Friend has effected in the latter figure.
If we are concerned, as we all are, to secure that the relationship is the right one, that undue pressure is not put upon companies on either side, the fact that one figure has been altered—whether in the hon. Member's opinion that has rightly or wrongly been done is not at this point material—must affect another. Therefore, it seems to me the force of his argument would have been stronger had the rest of the Bill remained as it was at the time that he tabled the Amendment.
§ Mr. Jenkins
The Financial Secretary is correct in his description of the chronological course of events. This is the first reason I have heard for the very odd order in which the Chancellor tabled his Amendment, one batch before the weekend and another batch afterwards.
§ Mr. Boyd-Carpenter
My view is that on the 12 per cent. basis for new capital and profits ploughed back, the 4 per cent. on the loan capital is right. Perhaps it seems to us just about as right as probably the previous figure, if the Amendment were accepted, would have seemed right to the hon. Gentleman, but that is a matter on which opinions can differ.
We went very carefully into the matter before tabling the main Amendment which is embodied in the new Clause, and although much of what the hon. Member has said is persuasive, as it always is, I am convinced that our figure of 4 per cent. is right in substance. This part of the operation of the tax will be watched, as all parts will be. The objective which I have already disclosed to the Committee, of seeing that the tax operates fairly in the sense of not penalising or over-encouraging other types of 1245 capital, will be borne in mind, but we are inclined to think at this stage that 4 per cent. is the right figure and that it should stay.
§ Mr. Gaitskell
The Committee is indebted to my two hon. Friends for raising this important matter and for the very clear and interesting speeches which they have delivered. I agree with the Financial Secretary that we are not on a major issue here. This is certainly a minor point, and a point on which one can legitimately accept his argument that it is a matter of opinion and judgment. I think my hon. Friends will agree that he has given us a courteous and clear reply.
I must admit that one of his arguments certainly weighed with me, and that was that since the Amendment was put down the Chancellor has increased the capital standard rate from 10 per cent. to 12 per cent. In comparing the position of a company desiring to raise capital by the issue of ordinary shares or by a loan the balance has, so to speak, by that Amendment of the Chancellor's been put rather further in the direction of equity capital. Therefore, the argument for reducing the figure from 4 per cent. to 2 per cent.—I have not had time to consult my hon. Friends—is to that extent weakened.
It has been useful to have the discussion. In general, we all agree that some allowance should be made, as both my hon. Friends have made clear, for an addition to profits arising out of the raising of additional loan capital. We have had a discussion on just how much there should be, but I do not feel that it is exactly a matter which we wish to press any further.
§ Amendment, by leave, withdrawn.
§ Clause added to the Bill.