Schedule 10.—(MEANING OF "DISTRIBUTION".) (Hansard, 22 June 1965)

§ Mr. Peyton
I beg to move, Amendment No. 685, in page 170, line 24, to leave out from the second "the" to the end of line 28 and to insert: former is a subsidiary of the latter or both are subsidiaries of a third company ('subsidiary' having the meaning assigned to it by section 42 (1) of the Finance Act 1938)". The effect of the Schedule as drafted is to treat the payment of interest under quite legitimate and sound commercial transactions as if it could be in the furtherance of some tax dodging device. Many such arrangements exist, as Treasury Ministers know, and many of them exist with specific Treasury approval. Because I cannot bring myself to believe that it is the Government's intention to interfere with such processes, I move the Amendment as briefly as this in the confident hope that the Chief Secretary will accept it.

§ Mr. Diamond
The point is well made, it is fully taken and the Amendment is accepted.

§ Mr. Peyton
I am very nearly overwhelmed. I only wish that the Chief Secretary had been on the Front Bench a little earlier this afternoon. I could have wished him here on at least one occasion. I am grateful for what he has done, I am glad to see him here and I hope to face him on many more occasions with similar results. I am very much obliged.

§ Mr. Diamond
I beg to move Amendment No. 693, in page 172, line 34, to leave out from "company" to "a" in line 36 and to insert: to a director who is not a whole-time service director but is".

§ The Deputy-Chairman (Sir Samuel Storey)
With this Amendment the Committee should also discuss the following: Amendment No. 576, in page 172, line 33, at the beginning to insert "so much of".
Amendment No. 577, in page 172, line 33, after "consideration", to insert: as represents more than a reasonable commercial rate".

§ Mr. Diamond
The effect of the Amendment and the other two which go with it, Nos. 694 and 695, is that loan interest payable by a close company will be treated now in much the same way as loan interest is treated for Profits Tax purposes, that is to say, it will be allowed as a deduction in computing the company's profits for Corporation Tax purposes unless either it is payable at more than a reasonable commercial rate or it is payable to a director or to an associate of a director. When I refer to a director of a company, I exclude the whole-time service director. A whole-time service director counts in this case, as in other cases, just as an employee, and there is no limitation therefore in respect of interest paid to him.
This is a relaxation of the previous tax avoidance provisions contained in the Clause. Representations have been made to my right hon. Friend that the previous provisions disallowing loan interest paid by close companies were rather widely drawn, and we now therefore adopt in their place the provisions which are drawn from Profits Tax and which have worked well there.
It will be readily seen that my right hon. Friend has gone a very long way indeed to meet the representations which have been made, and of course it will cause the Committee some anxiety, because no right hon. or hon. Member on either side of the Committee is anxious that the Chancellor should go so far as to encourage any possibility of tax avoidance. We recognise this anxiety on both sides of the Committee, and my right hon. Friend therefore will be careful to watch the effect of the proposed Amend- 1630 ment, if the Committee is good enough to accept it, during the course of the coming year.
If we have gone too far, and have left some scope for avoidance, appropriate counter-measures will have to be taken, but in the confident belief that the previous draft was perhaps a little harsh, and that although this may be a little too lenient, those who are concerned, the directors of close companies, will respect the leniency and make the thing work comfortably and conveniently, I think that my right hon. Friend is perhaps not going too far.

§ Mr. W.R. van Straubenzee (Wokingham)
We have moved on to a part of Schedule 10 which has important ramifications, and I hope that I shall be forgiven if I take a minute or two to say something about the other two Amendments which are being discussed with this one.
The provisions which the Government are now doing a considerable amount to amend were among the provisions which, when first published, caused widespread anxiety among the directors of close companies. This is but one further example of a retreat on an important point to do with the provisions for close companies which I do not think would have been necessary if the provisions had been properly thought out in the first place.
The combined effect of these Amendments could also have been secured by accepting the Opposition Amendment No. 474 to Schedule 17, which we shall be discussing at a later stage. I merely place this on record as something on which we on this side of the Committee worked at an early stage.
The position is still that interest paid to directors or their associates is caught by the provisions of the Bill. Let me illustrate the sort of case that will still be caught. A director has associates as defined by the Bill. As we know, associates can be relations—for example, if his children are beneficiaries of a trust. The associate has accumulated savings which are on ordinary deposit at 5 per cent. The company, on the other hand, has a secured bank overdraft on which it is paying 8 per cent. It would be an ordinary sensible business transaction for the associate to lend the company money at some rate less than 8 per cent. It 1631 would be beneficial to all concerned, it would be a commercial transaction, and that is why, Sir Samuel, the Amendments which you have been good enough to say we may discuss with this one imports an element of reasonable commercial consideration. That was the reason for their being drafted in that form.
It must equally be said in fairness from this side of the Committee that, of course, the Revenue must have powers in this respect, because it is perfectly conceded that a number of these transactions are not at arm's length. But the effect of the Clause, even improved as it is, is to penalise all such transactions with directors even if entered into under contract before the publication of this Bill.
For these reasons, while I appreciate that it is not open to this side of the Committee to press our two Amendments by way of Division because you are not calling them for that purpose, Sir Samuel, we had to spend a moment to explain them.

§ Mr. Patrick Jenkin
I would like to add briefly to what my hon. Friend has said about this. As he rightly emphasised, paragraph 9 of Schedule 10, taken with the definition of the participator in Schedule 17, which includes the loan creditor, can operate as a very severe penalty on close companies who borrow money, let us say, from members of the family. If the loan is allowed for Corporation Tax purposes,£100 of interest gross cost£100 of profits. If the loan is disallowed—and as the Bill now stands it will be—with a 35 per cent. rate of Corporation Tax that loan interest will cost£153 16s. 11d., and if the Corporation Tax is at 40 per cent. the cost to the company of a loan interest of£100 will be£166 13s. 4d.
This is a very swingeing penalty, and the objection to it is that in order to try to catch—quite laudably—the tax fiddler, the man who tries to take advantage of the procedure, all sorts of entirely reputable and sensible transactions are going to be swept into the net and penalties of this magnitude imposed.
My hon. Friend gave one example. Let me give another—the young man who is a director of a small family company who sees the need for extra finance. He is 1632 unable to interest any financial institution, and he goes to uncle. Uncle, who is a ruthless self-made businessman, demands his pound of flesh but is willing to back the young man and lends the money at a commercial rate of interest in order to give the young man the chance of expanding his business. The whole of that interest, because he is an associate, a director, will be disallowed, and the business will accordingly be penalised.
The Amendments which we had set down would, in these circumstances, have allowed the interest up to a reasonable commercial rate to be treated as a deduction and not as a distribution to a participator. This does seem to me to be a very necessary modification to this Bill, and I hope the Chief Secretary will be able to offer some hope that between now and Report stage he will examine this problem again, because it can give rise to considerable hardship.
The Chief Secretary was good enough in yesterday's debate to acknowledge the concern these provisions had aroused, but none has aroused greater concern than this and his Amendment only goes a very small way towards alleviating the position.

§ Mr. Stratton Mills (Belfast, North)
The Chief Secretary has been good enough to look with some flexibility at this point, but I am not convinced that the Government Amendment is entirely satisfactory. Like my hon. Friends, I would much prefer to see a test based on reasonably commercial considerations. One anomaly has been created by the Amendment. If a young man starting in business obtains a loan of£10,000 at a rate of 10 per cent. from someone who is not related to him in any way, if the lender puts his accountant on the board the interest is allowable for Corporation Tax, but if the lender himself sits on the board the interest is not so allowable, and instead of the interest being£1,000 per annum it will be£1,538 9s. I do not think that this is the kind of situation which the Treasury Bench envisaged, and I hope that it will be possible to put the matter right with a later Amendment.

§ Sir Lionel Heald (Chertsey)
There is one other anomaly. As I understand it, the Amendment would have the effect of applying to a person who is an associate 1633 of a director. The word "associate" is defined an page 210, in the Seventeenth Schedule, as husband or wife, parent or remoter forebear, child or remoter issue, brother or sister, and partner". The right hon. Gentleman has said that there was no possibility of evasion, but if the associate of such a director happened to be his mistress that would apparently give ample provision for evasion.

§ Mr. Diamond
This confirms what I said previously—that both sides of the Committee are anxious that there should not be tax avoidance. I am grateful to the right hon. and learned Member for Chertsey (Sir L. Heald) for pointing out the possibility of evasion, and I readily undertake to consider the point that he has raised.
As to the other points raised, by the hon. Member for Wokingham (Mr. van Straubenzee), the hon. Member for Belfast, North (Mr. Stratton Mills) and the hon. Member for Wanstead and Woodford (Mr. Patrick Jenkin), their judgment is one of a number of hon. and right hon. Members who are not accustomed to tax avoidance, and although the hon. Member for Wokingham was good enough to admit that there is a possibility of tax avoidance here, and that the Revenue must be reasonably protected, it is right to point out that one's judgment varies according to whether one is concerned with this point. The right hon. Member for Bexley (Mr. Heath) takes the view that we are obsessed with this matter; we take the view that we have to protect the Revenue and see that each taxpayer bears his fair share of taxation.
It is merely a matter of how far one should go. There is no dispute between the two sides. If we go completely to the extent of preventing tax avoidance there will be some bona fide hard cases, but if we go completely the other way we open the door to tax avoidance. We have to arrive at a reasonably half-way house.

§ Mr. Patrick Jenkin
What is the objection to allowing the first slice of interest, up to a reasonably commercial rate, in all these cases?

§ Mr. Diamond
The objection is that if this is, in effect, a return on capital it 1634 should be treated as a return on capital. That is the position we have to protect. Had we been continuing Profits Tax in its present form the loophole of the associate would have been a matter that we should have had to deal with, in any event. Tax avoidance does arise, and therefore we have to deal with it. My right hon. Friend has gone a long way; everybody recognises this. He has gone as far as he should be asked to go. My interest is the reverse of the hon. Member's; my view is that there will be more cases of tax avoidance than bona fide hard cases.
In short, I will as a matter of courtesy, but not in any other sense, look at the suggestion which hon. Members have made. I must tell them in all fairness that it has already been considered, but I will take into account the representations they have put; although I think that the Amendment I have urged on behalf of my right hon. Friend meets all the reasonable cases. I will look at their point between now and Report stage with the qualification I have made clear.

§ Mr. Diamond
I beg to move Amendment No. 717, in page 173, line 34, to leave out from beginning to "as" in line 35.
This Amendment corrects a drafting error whereby there is a choice of two alternatives in the Bill. One course, we think, is sufficient.

§ Sir John Hobson (Warwick and Leamington)
I beg to move Amendment No. 653, in page 173, line 41, at the end to add: