HC Deb 19 June 1951 vol 489 cc349-61

Paragraph 4 of the Fourth Schedule to the Finance Act, 1937, shall be amended by the insertion of the following: Provided that any payment of fixed preference dividend on shares authorised or in issue on or before the tenth day of April, nineteen hundred and fifty-one, shall not be regarded as a payment of dividend or distribution of profits, but shall be regarded as a payment of interest for the purposes of the profits tax."—[Mr. Birch.]

Brought up, and read the First time.

Mr. Nigel Birch (Flint, West)

I beg to move, "That the Clause be read a Second time."

At the present time, money distributed in preference dividends ranks for the purposes of Profits Tax in exactly the same way as money distributed as dividends upon ordinary shares, though, of course, all the money for the tax actually comes out of the pockets of ordinary shareholders and not out of the pockets of the preference shareholders. On the other hand, money distributed as interest on loans or debentures ranks as an expense against profits, and is charged against those profits before a balance is struck which is subject to Profits Tax both on distributed and undistributed profits.

What this new Clause seeks to do is to put fixed preference dividend payments—I emphasise the phrase "fixed preference dividend payments"—in the same position as interest upon loans for the purpose of assessing liability to Profits Tax. It is an old anomaly with which this Clause seeks to deal, and it has existed ever since the Profits Tax was first imposed, but, since the tax was first imposed, the whole scale of the tax has altered, and the alteration of the scale alters the position fundamentally. After all, if we tax something at 5 per cent., it might create an anomaly, but, if we tax it at 50 per cent., it might prove to be a real injustice.

My hon. Friend the Member for Angus, North (Mr. Thornton-Kemsley), mentioned what the "Economist" said on this subject the other day, and I would like to quote one sentence from that article, because it should go upon the record. The "Economist," in its article upon the Budget, said this: To have raised the distributed Profits Tax to 50 per cent. without making any attempt to end the fantastic anomaly of equity shareholders bearing its full weight, not only in respect of their own dividends but also in respect of preference dividends, is surely impossible to reconcile with the Chancellor's professed object of penalising dividend increases. That seems to me to put the main case against what the Chancellor has done very clearly, but I should like to add to it a certain number of other objections to the effect of this tax.

The first is that the tax is grossly unjust as between different companies. We may have companies making the same amount of gross profits, one of them with a certain amount of debentures, one with large preference capital and another with neither. They would all pay quite different rates of tax on the same gross profits. Not only will they pay these different rates of tax, but, at the time their capital structure was set up, it was quite impossible for them to know that they were likely to let themselves in for different rates of tax.

Clearly, if anyone had known in the 30's, we will say, that the distributed Profits Tax was likely to be anything like 50 per cent., no one would ever have issued preference capital. On the other hand, not knowing that, they were clearly right to issue it, because it was considered a much more prudent thing to do to have a certain amount of preference capital than to over weight the company with loan capital.

The effect, as in so many of the Government's other actions, is that somebody is penalised for doing something which, at the time he did it, was clearly right, not only in his own interests, but in the national interest, and it penalises him in a way which it is very difficult for us to see how anyone could foresee. I think we rather lower morale if we go on penalising people for doing what is right simply because it suits the Revenue to do so. Therefore, the first reason I put up is the inequity as between different companies.

The second reason is that a preference dividend is in the nature of a fixed charge. or, rather, is to a certain extent analogous to a debenture charge. If the credit of the company is to be worth anything, it has to pay the preference dividend, and it cannot do anything to reduce it. Therefore, in the context of this tax, the analogy between the preference dividend and the debenture is very close.

The third reason is another case of injustice. Supposing a company has been in low waters—as many companies even now still are—and is now getting out of that difficulty, but incurred during that period of difficulty considerable arrears of preference dividends. If it seeks to clear off those arreas, all money distributed for that purpose would be liable to a Profits Tax of 50 per cent., whereas during the time the default was incurred, the tax was nothing like so high. Therefore, through a misfortune, the company would incur a far higher level of tax than if it had been more fortunate. It means that we are kicking somebody who has had a misfortune, and I think that is an injustice.

My fourth and last reason is the one I touched upon just now, that the present set-up of the tax makes it almost certain that the great weight of new company finance will have to be raised by loan, and we have seen some startling examples of that during the past year. Many large companies have raised loans—very often short-dated loans—and very few indeed have raised fresh preference capital. On a long-term view, that is most damaging to the capital structure of our industrial companies, because, if they fall on evil times, they have no cushion, as it were, by way of preference capital which they can pass. They are liable to be in queer street, and to have to put themselves in the hands of the banks.

At the moment, a company is almost forced by this tax to raise money by loan rather than by preference capital. Of course, they are not precluded in any way from raising ordinary capital, but it gives an immense fiscal encouragement to companies to incur debt to a greater extent than prudence and good management would allow. This anomaly is only an aggravation of a tax which is in itself a bad tax.

I would pray in aid some words used by the right hon. Gentleman the Minister of Local Government and Planning on the subject of this tax, and I think that all sections of the party opposite will like to agree with him, because, judging from his week-end speech, he is not only running with the Government hare but hunting with the Ebbw Vale hounds, which is, of course, very acceptable to both sides. Some years ago when describing the tax he used these words: It is a bad tax, a tax on risk bearing tending to divert the flow of capital from risky to comparatively safe investments. We are continually told that one ought to be a merchant adventurer. But it is difficult to be a merchant adventurer when the dice is so heavily loaded against one by a bad and anomalous tax.

9.0 p.m.

It is doubly bad—and this is something which bears on all these direct taxes—for it is levied on paper profits and not upon real profits. I must recur for a moment to what the Chancellor said about this the other day, since with a terrifying display of synthetic anger towards me and some of my hon. Friends he said we were all wrong to talk about paper profits because the Millard Tucker Committee, whose Report he averred we had never read, said paper profits were true profits. They did not actually say that. They assumed that. What the Committee said, in paragraph 8 of their Report, was: … we took as the first of those principles.…"— the principles they were working on— that as nearly as practicable the taxable profits should be no more than and no less than the true profits of the business as computed on established accountancy principles. That is to say, they assumed that profits arrived at on established accountancy principles were true profits for the purposes of their argument. They went on to point out that these were not true profits at all in any real sense. Therefore, I hope that that argument will not be used from the Government Front Bench again.

The point I am making is that this high tax, aggravated as it is by the anomaly of preference distribution ranking for it, is doubly bad because it is raised on profits which are not true profits at all. The Millard Tucker Committee also examined the situation and said about it almost exactly what they said about every other problem they examined. They started by doubting whether it was in their terms of reference, then said it was a bad anomaly and something should be done about it and said they very much hoped that the Cohen Committee would do something about it. That, of course, is a very sound way of writing a report and gets one into very little trouble.

I urge the Committee to accept this Clause because I believe the present situation is getting out of hand. It is damaging to enterprise, it is damaging to the structure of company finance and it is in itself unjust.

Mr. J. Edwards

Before the hon. Member sits down, would he tell me whether he was purporting to summarise the Millard Tucker Committee Report on this particular matter in what he has just said?

Mr. Birch

Yes, indeed. I think it was a fair summary. I will read it all out to the hon. Gentleman if he likes.

Mr. Derek Walker-Smith (Hertford)

I rise to support the Clause which has been commended to the Committee with characteristic lucidity and persuasive force by my hon. Friend the Member for Flint, West (Mr. Birch). The Committee will recall that there were earlier passing references to this topic on the occasion of the debate on the Motion that Clause 24 stand part of the Bill. It was very disappointing that on that occasion the Chancellor made no reference to the observations that were made about the position of fixed preference dividends.

However, there was some encouragement to be had in that one of the embryo Chancellors of the Exchequer sitting on the back benches opposite, the hon. Member for Stechford (Mr. Jenkins), in the shortest and, as I thought, the best part of his speech on that occasion said there was something in the point that was made about the position of fixed preference dividends under Profits Tax. He expressed the hope that the Chancellor would consider their position. I hope that if other voices do not sound very sweetly on the ear of the Economic Secretary to the Treasury, the voice of his hon. Friend the Member for Stechford will reinforce them.

There was a good deal of reference on that same occasion to the percentage of profit taken by taxation, chiefly turning on the two extreme cases—either where all the profit was distributed or where none was distributed. Both of those cases are presumably unlikely cases, in that in the ordinary way some percentage of the net profit after taxation would be put to reserve. If only 20 per cent. of the net profit after taxation is put to reserve, which would be a modest amount in an inflationary situation, my estimate is that in that case 64 per cent. of the chargeable profit would be taken by taxation, 7 per cent. would be transferred to reserve and 29 per cent. would be available for dividend. Of course, if a higher figure than 20 per cent. goes to reserve, then that figure of 29 per cent. is by so much the lower.

It is by no means improbable in a case of companies with a highly geared capital structure or with considerable arrears of preference dividends that the 29 per cent. will be wholly or very largely required for the payment of fixed preference dividends. That, of course, places companies in that position on the horns of a very painful dilemma. They must either prejudice the ordinary dividend or the reserves, or both; and when I say "prejudice the ordinary dividend" I am not talking in terms of prejudicing an increase in the ordinary dividend which might be said to be a counter-inflationary measure, but prejudicing its maintenance on the present level or even its very existence.

There are two questions which the Committee should bear in mind in considering this question. The first is whether the position is just in regard to companies at the present time, and the second is whether the effect on the future capital structure of companies will be economically advantageous. I want to say a few words on both those considerations. As to the justice of the present position, which has already been referred to by my hon. Friend the Member for Flint, West, broadly speaking it is right to say that when the law changes to the disadvantage of an individual or a company they have to put up with it; but there must be some limits to that doctrine. There must be some regard to the violence and the unexpectedness of the change.

When this matter was last debated, in the Finance Bill debate in July, 1947, the matter was comparatively unimportant because at that time the percentage of extra Profits Tax on distributed profits was only 7½ per cent.; it was subsequently retrospectively increased to 15 per cent., but it was only 7½ per cent. at the time when it was debated. It follows that the present position bears no real relationship to the position at that time; it was unforeseeable both at that time and at the time when many companies were raising capital.

A completely different situation presented itself to many companies when arranging their capital structure than what has turned out to be the case in this violent transformation in the course of four short years. The Committee are well aware of all the various disadvantages attaching to the raising of capital by way of debentures or loan capital and of the desire of a company to avoid, if it can, a charge on its assets and to avoid the various other disadvantages which apply to the issue of debenture shares.

But there can be no doubt that if the position could have been foreseen by many companies at the time when they made their decision, then the impact of the Profits Tax at its present level would have completely overwhelmed those other considerations which then seemed to be the strongest factors to be taken into account.

In the debate on the Motion that the Clause stand part of the Bill my hon. Friend the Member for Barnet (Mr. Maudling), recalled that one of the Law Officers of the Crown said, in the 1947 debate, that companies could change their capital structure if they wished to avoid these disadvantages, and my hon. Friend, with characteristic moderation, observed that he did not think it was as simple as all that; and in so doing, if I may respectfully say so, he was if anything guilty of some degree of understatement.

Mr. Birch

Meiosis.

Mr. Walker-Smith

If a company wishes to take that course it has to pursue a sort of obstacle race in order to achieve it, because it would entail replacing part of the existing share capital with loan capital. The company would encounter the difficulties of obtaining the sanction of the court under the Companies Act, there would be the difficulties of getting the approval of the Capital Issues Committee, and, finally, there would be the insuperable difficulty presented by Clause 28, which stands on guard against any such efforts that may be made in the future.

The position is now, therefore, that companies are bound to a course the hazards of which could not possibly have been charted at the time when they set out upon it. Hon. Members opposite may take the view that it is the business of ordinary shareholders to take risks and that this is one of the risks they should bear, but I submit that it is the business of the ordinary shareholders to take ordinary risks and that this is an extraordinary risk quite beyond the contemplation of the parties, to use a phrase so common in our contract law.

Perhaps I may say a few words on the other aspect of the matter—whether the future economic consequences will be advantageous. My hon. Friend has already pointed out—as is the fact—that the necessary effect of this increase in the Profits Tax and of the Profits Tax position will be that companies will no longer have resort to preference share capital but will have resort to loan capital; and that will lead to the well-known economic and industrial disadvantages of companies being driven at the first time of asking, so to speak, to raising capital by means of loan capital, with all the various possible complications of appointments of receivers. debenture holders' actions, and so on.

It will, therefore, clearly be bad for companies, and I should have thought it would be bad for the Treasury, too, which may be an argument which will appeal more to the Economic Secretary; because if this is the effect, then the position of the Treasury will be that instead of getting 30 per cent. by way of Profits Tax at the old rate on preference dividends they will be getting nothing at all by way of Profits Tax on the debentures which, in the company structures of the future, are likely to replace a fixed preference dividend.

The Clause, in fact, embodies the first, and the better, of the two suggestions for dealing with this matter made in the Millard Tucker Report. Paragraph 323 of that Report says: We have much sympathy with these views, but we regard the problem as falling outside our terms of reference. The suggestion that fixed rate preference dividends should be treated like debenture interest might indeed appear to he a matter for us as being a question of the proper deduction to be made in computing profits. 9.15 p.m.

They go on to say that they cannot make a positive recommendation, as my hon. Friend has explained, in regard to them, but it is clear to the average person reading their words, at least, I think it is clear—the Economic Secretary shakes his head; of course, a written document speaks for itself; neither he nor I nor anybody else is capable of interpreting a written document—that if they had considered the matter to be within their terms of reference they would have considered this to be an acceptable and an equitable solution. Whether or not it was in the terms of reference of the Millard Tucker Committee, it is certainly within the terms of reference of this Committee, and I submit that we should correct this grave anomaly.

Mr. J. Edwards

I think we should be clear at the outset that the hon. Gentlemen who are sponsoring this Clause are, in fact, proposing that the charge of Profits Tax, now at 50 per cent. under Clause 24, on distributed profits, should not apply to fixed preference dividends, but that instead these amounts should be deducted in computing profits subject to Profits Tax. This is the most thorough going new Clause or Amendment that we have ever had on this theme. It goes much farther than anybody from the Opposition has hitherto proposed.

It is not clear from when this Clause would operate, but it is, I think, a radical challenge to the whole of the Profits Tax principle, and, if it were adopted, would, in fact, completely wreck the Profits Tax. [HON. MEMBERS: "No."] There are, it seems to me, very great anomalies created anyhow. After all, it is part of the scheme of the Profits Tax that the charge at the higher rate should fall on all dividend distributions, including payments of preference dividends. [Interruption.]

Perhaps, the right hon. Gentleman the Member for Aldershot (Mr. Lyttelton) would consider this point. If preference dividends were to rank as deductions in computing profits for Profits Tax purposes then, I think, he will agree with me, a company with a large preference share capital would be greatly favoured as compared with a company with a large ordinary and a small preference share capital. The truth of the matter is. I submit, that this is an extremely complicated matter, certainly not to be dealt with in the way which is suggested in this new Clause.

There were discussions several years ago between the Federation of British Industries and the then Chancellor of the Exchequer on the matter. Reference has been made to the Millard Tucker Report. The hon. Member for Flint, West (Mr. Birch), gave what I thought was a somewhat tendentious summary of it. The hon. Member for Hertford (Mr. Walker-Smith) did something which, from my point of view, was much worse. He read three or four sentences from one paragraph and then stopped at the point most convenient to him. Perhaps I may be permitted to go on with the quotation from where he left off. The Report goes on: The payment of preference dividends is, however, an appropriation of profits to a particular section of the owners of the business and starting from the premise that Profits Tax is a tax upon the profits of a company, we cannot agree that such dividends can properly be deducted in computing the amount of a company's profits. The suggestion is in reality one for a change in the nature of the tax, for it implies that the profits to be charged should not be the full profits of the company, but the ordinary shareholder's share (whether or not distributed) of those profits. It would clearly he outside our terms of reference to recommend so fundamental a change in the nature of the tax. That seems to me important, and it bears out the point which I have already made, namely, that we are here concerned with a very difficult and extremely complicated subject, not to be dealt with in the somewhat superficial way proposed in the new Clause.

Mr. Walker-Smith

If the hon. Gentleman would allow me, I would observe that it just goes to show how very ill advised an hon. Member may be to have regard to the time of the Committee. I should have hoped that the hon. Gentleman would have known better than to suggest that I had deliberately omitted any part of a very lengthy paragraph in order to assist my argument. Since the hon. Member has chosen to make a reference, which I hope he will realise is unjustified and for which I venture to hope he may express some measure of regret, may I point out to him that I made it clear that the Millard Tucker Committee said in this paragraph that the matter was outside their terms of reference? The whole of the passage which he has read to the Committee, and which he has abused me for not having read, is merely leading up to that conclusion on the part of the Millard Tucker Committee. I stated the conclusions; I did not apprehend it was necessary to state every argument that they gave in support of it.

Mr. Edwards

I do not suggest for one moment that the hon. Gentleman wanted to conceal anything from the Committee, but the fact does remain that the Millard Tucker Committee confirmed precisely what I said in the part that follows the section which the hon. Member read to the Committee, namely that they were here concerned with a matter which they said was "so fundamental a change in the nature of the tax."

Quite apart from anything else, I must draw the attention of the Committee to the fact that the effect of this Clause would be almost to halve the yield and the amount net would be something like £31½ million, which, if there were no other grounds on which the Clause could be resisted, would put it quite out of count in our present circumstances.

I would not dispute that there is room for a good deal more thought and consideration about what should be a definition of profits. Hon. Members opposite talk about real profits. I would not dispute that there is a field of inquiry here of the utmost importance, and if ever we were to adopt the kind of principle involved in this Clause I suggest that we should only do it after the most mature and careful consideration.

I would not for one minute dissent from the view that there are genuine difficulties arising from the inter-relation between the financial structure of companies and taxation imposed, but this is a complicated subject, which is precisely the kind of thing on which we should look forward to having considered advice from the Royal Commission on Taxation. For those reasons, I ask the Committee not to agree to the Clause.

Mr. Lyttelton

What we have just listened to shows one or two very great errors in the mind of the Government. First of all, it shows a profound ignorance of the nature of preference shares. I will turn aside for a moment to say that any form of taxation that necessarily imposes upon companies a definite form of capital structure is in itself bad. Preference shares have only one merit in my opinion, and that is that they are irredeemable. If the hon. Member looks at the matter for a second he will find that most financial authorities agree with that. They differ in no respect from debentures except that they have no security. They are proprietary shares and no one invests with the same confidence in preference shares if those preference shares are redeemable.

The Millard Tucker Report has something to say on this subject, and I hope I shall not be accused of taking sentences out of their context. It says: It was represented to us that preference dividends, particularly where they are at a fixed rate and are cumulative, are much nearer to debenture interest than to ordinary dividends. It is an unquestionable fact that when a business prospers a proprietor gets a preference dividend from his preference stocks at a fixed rate, but that when the business is not prosperous he gets no security. He remains the proprietor without the benefits. The only difference between the preference stockholder and the debenture holder is one of security.

Therefore, it seems to us—in spite of the Economic Secretary's view that this is a complicated matter and that we are waiting for the Royal Commission on Income Tax—to be a simple matter. In all equity, a fixed preference dividend ought to be treated as a charge against the business. Even the Millard Tucker Report, amidst a lot of waffle which it goes into on this subject, comes down clearly on the point that a preference dividend at a cumulative rate is much nearer to a debenture interest than to an ordinary dividend. I think that the ordinary man would agree with me.

Mr. J. Edwards

The right hon. Gentleman says that the Millard Tucker Report comes down on this point, but the section which he read said: It was represented to us … that is to say, a representation is recorded in the part which the right hon. Gentleman read. That does not necessarily mean that the Committee accepted the statement.

Mr. Lyttelton

The Committee was presided over by a lawyer. The hon. Gentleman is doing the profession a great disservice by suggesting that they ever come to a clear-cut decision. I have read it as a blunt man.

The other question which I want to raise very briefly is the arrears of preference dividends. There, again, is a general unfairness in trying to raise Profits Tax on what is a fixed interest bearing security, only differing in kind from a debenture. The Economic Secretary ought to consider whether it does not seem a bit stiff that somebody who lends his money to a company and is out of his money for a long time should now be charged Profits Tax upon the distribution, when he has been without any dividend upon his preference shares for many years. I should have thought that the Treasury, instead of hiding behind a Royal Commission, would have given us a little more consideration, and I am disappointed. A clear case has been made out for some alleviation in respect of preference stock or shares.

Question put, and negatived.

First and Second Schedules agreed to.