New Clause.—(RELIEFS FROM PROFITS TAX WHEN FRANKED INVESTMENT INCOME NOT EXCEEDED.) (Hansard, 28 June 1951)

§ Sir John Mellor (Sutton Coldfield)
I beg to move, "That the Clause be now read a Second time."
I think I should say that I have some private interest to disclose in this matter. This proposal is a very simple one. It is that, where dividends are covered or more than covered by franked investment income, the remaining income of the company shall be treated as undistributed. In other words, the company should be permitted, if it chooses, to pay its dividends out of the franked investment income if it is sufficient. So far as I can see, in all possible circumstances the company would so choose if it were permitted to do so, but under the law as it stands that, I should have thought, very reasonable right is not permitted, because the Finance Act, 1947, apportions dividends out of franked and unfranked income. That denies to a company the right to elect how it shall distribute its profits. We say that the company should have the right to elect.
The franked investment income of the company has already paid 50 per cent. Profits Tax. Why should 50 per cent. Profits Tax be paid again on any portion 1649 of that franked investment income? Why should more than 10 per cent. tax be paid on any of the undistributed profits? Three years ago I moved a new Clause identical with this, and the present Attorney-General—the Solicitor-General as he then was—resisting the proposal, said, in column 1795 of the daily edition of the OFFICIAL REPORT: It seems to me the obvious thing that when there are two categories of income, franked and non-franked, one assumes, what is the likely state, that when a company distributes any part of its profits it distributes proportionately out of all sources of income—a proportion of its franked income and a proportion of its non-franked income. The right hon. and learned Gentleman used the expression "one assumes, what is the likely state." I should have thought it was not only an unlikely state but an impossible state that any company would choose so to distribute its profits as to increase the burden of taxation upon it. The right hon. and learned Gentleman continued: In deciding what distribution charges to pay, we take a proportion of the gross relevant distribution and convert it into a common relevant distribution and, therefore, have a distribution subject to the charge, and eliminate from it a fair proportion representative of the amount attributable to its franked investment income."—[OFFICIAL REPORT, 7th June, 1948; Vol. 451, c. 179–6.] I have no doubt that the right hon. and learned Gentleman will explain quite simply what that means. I am afraid it is beyond me. At any rate one thing is clear. It is much less advantageous to the company, and is also extraordinarily complicated and confusing. Yet it is that extraordinary method of calculation which the right hon. and learned Gentleman described as a likely state for the company to prefer. I should have thought that any company which preferred that ought to be in a mad-house. Why should not we deal with this matter in the perfectly simple and reasonable way I have suggested?
I think that we have even stronger grounds now than we had to ask for this three years ago, because since 1948 the distributed Profits Tax has been doubled. I am asking this, first of all as a matter of justice, and also as a matter of convenience. It would be far simpler to let the company do what it would do in all other circumstances, if it were not prevented by the express terms of the 1947 Act, and decide when paying its dividends 1650 which part of its income it will make payment from. The company would normally elect to pay out of the franked investment income, and then the distributed rate of Profits Tax would attach once only. I hope that the Government will give a more favourable answer to this suggestion than they did three years ago.

§ Mr. G. P. Stevens (Portsmouth, Langstone)
I beg to second the Motion.
I listened with great interest to the remarks of the hon. Member for Sutton Coldfield (Sir J. Mellor), and I have read with equal care and interest the remarks of the Solicitor-General, as he then was, when he rejected a similar Clause three years ago on the Committee stage of the Finance (No. 2) Bill. I, personally, am very much struck by an important underlying difference in principle. The Solicitor-General rejected the Clause on that occasion because he said it could not possibly be fair to the Revenue. I think that it is important that we in this House should always be fair to the Revenue, but as I listened to the hon. Baronet it struck me that we must also be fair to the taxpayer, and it seems to me that Section 30 of the Finance Act, 1947, as at present operated, is far from fair to the taxpayer.
It is certainly not a principle of taxation in this country that in general income which has already borne tax at the full standard rate, whether Income Tax or Profits Tax, should suffer taxation again; yet undoubtedly that is what is happening in this particular case. The hon. Baronet referred a few years ago to the way in which the net relevant distribution is calculated, and said that the principles are defined in an extremely complicated way. That is very true, and I do not pretend to understand them fully myself, but I hope to give some simple illustrations which show the double taxation effect which exists at the present moment.
A company has a trading profit of £20,000 and a franked investment income, which means income in the shape of dividends, either ordinary dividends or preference dividends, which have, in fact, borne Profits Tax at the full rate of £5,000, a total of £25,000. That company distributes a dividend on £5,000, and, under the existing law, the double taxation effect brings out what seems to me to be the grossly unfair result that Profits Tax, not at the full rate but at an 1651 effective rate of about 40 per cent., is payable on four-fifths of the £5,000 franked investment income.
The right hon. and learned Gentleman will, I am quite sure, be able to check the arithmetic in that case, and, similarly, the arithmetic in another example where trading profits are again £20,000 and the franked investment income £10,000, a total of £30,000, and the whole of the franked investment income is distributed as dividend. Here we find, under the existing taxation law, approximately 40 per cent. is payable on three-quarters of that sum, namely, £6,666 on £10,000 of income which has already borne Profits Tax at the full rate. I cannot believe that justice is served in that way.
I support this Clause most strongly on two grounds: first, that there is at present a substantial amount of income which is double-taxed or taxed at the full rate and consequently at far more than a non-distributed rate, and second, there is the point which the hon. Baronet made so strongly three years ago and made again this afternoon, that if this new Clause is accepted there will be, for obvious reasons, a strong inclination on the part of boards of directors to restrict their distribution to franked investment income; in other words, a kind of voluntary dividend limitation which, I should have thought, would have the strongest possible appeal to the Chancellor of the Exchequer.

§ The Attorney-General(Sir Frank Soskice)
We have considered this new Clause again, but we feel there is really no reason to depart from the attitude which we adopted when it was discussed some two years ago. May I try to restate the argument in this form? It is common ground between us that one has to try to be fair both to the taxpayer and to the Revenue. A company, of course, has different sources of income. It has its ordinary income which it earns and this other income, which is called franked investment income because it has borne tax in the hands of some other company. Faced with this situation of a company having this dual stream of income, one has to be fair both to the taxpayer and to the Revenue in working out how we are to apportion the distribution of these two streams of income.
1652 The hon. Baronet proposes that it should be regarded as coming out of the franked investment income. That is what he wants when he says that the company should be allowed to choose from which source it should be regarded as coming. On that principle, it can be said with an equal measure of justice for the Revenue that they should be entitled to claim that the whole of the distribution should come out of the earned income and the franked investment income should not be taken into account at all. Those are the opposite extremes.
The hon. Baronet's proposal is the one most in favour of a company and the alternative view is the one that is most in favour of the Revenue. What the Profits Tax legislation has sought to do is to work out a compromise between these two extreme views. Both the views I have mentioned would be unfair. The hon. Baronet's view is unfair to the Revenue and the other view is unfair to the taxpayer.
The obvious compromise is the one in fact adopted under the Profits Tax scheme. As the hon. Baronet has pointed out, the scheme which is adopted is one under which the distribution is considered as coming rateably from two sources of income. We apportion it to each source of that income and consider it, therefore, as flowing in a rateable proportion from each source. That means that the company does get that measure of relief which is fair upon the compromise view, and neither the taxpayers nor the Revenue have it in their power to say, "You are to consider this distribution as coming solely from one or the other." The compromise is to consider it as coming rateably from the two.
Having carefully considered the Clause and the arguments used before and repeated again today, we do not see that there can be any ground, or any reason in justice, for departing from the view we previously held. If we do depart from that view, how far is it to go? If one says to a company that it is to have it entirely at its own discretion as to what source of income is to be treated as producing the distribution, the company can go on to say, "We would like to treat that source as the source of earned income before 1947 and pay no tax on it at all."
1653 Once we say that a company is to be entitled to say at its own discretion where it is to treat the distribution as coming from, the result is to put the Revenue in a wholly unfair and disadvantageous position. I hope that the House will agree that this Clause ought not to be accepted, because it proposes a departure from a compromise which, I think, is fair to both sides.

§ Mr. Stevens
Will the Attorney-General say whether he thinks it is fair that income which has already been taxed at the full rate of Profits Tax should again be taxed in the hands of the recipient at a rate approaching the standard rate, thus bearing tax twice?

§ The Attorney-General
It is not as if that were a fact. It is not as if a particular distributed pound could be traced to a particular pound of investment income. The whole amount which has been distributed is divided on a purely notional basis and in proportion. No single pound can be said to have borne tax twice.

§ Sir J. Mellor
Could the Attorney-General give another example of this extraordinary treatment of the affairs of a company by statute?

§ The Attorney-General
That question assumes the premise that this is extraordinary treatment. The whole basis of my argument was to show that this was a perfectly reasonable compromise.

§ Sir J. Mellor
Is there any similar treatment?