HC Deb 21 March 1972 vol 833 cc1357-69

In last year's Budget speech I announced my intention to reform the structure of corporation tax in order to remove the present discrimination between retained and distributed profits. I explained that this discrimination distorts the capital market, tends to misallocate scarce investment resources, impedes companies that need to raise equity capital, and lessens the pressure for efficiency.

In the Green Paper on the reform of corporation tax which I published last year it was stated and explained that in order to achieve our objective there were only two real alternatives, a two-rate system or an imputation system which could be very similar in substance. Those two alternative systems were fully described and I invited views about the choice.

Since then there have been important consultations with industry, commerce and the professions about the alternative systems. These have been invaluable, and I think the House will agree that they have fully justified the decision not to introduce legislation until those who would be mainly affected by it had been consulted.

In addition, the choice set out in the Green Paper has been considered by the Select Committee under the distinguished chairmanship of my hon. Friend, the Member for Walsall, South (Sir H. d'Avigdor-Goldsmid), and we now have the benefit of its views. That Select Committee, like the Green Paper itself, was a new departure, although it was one which put into practice the view often expressed by those of us on this side of the House, that major tax changes should so far as possible be preceded by full and careful public consultation. The Select Committee completed its task with thoroughness and speed, and the whole House will agree that its report fully justified the innovation.

I should tell the House, frankly, that last year when I announced the proposal to reform corporation tax I had a preference on domestic grounds for the two-rate system.

Having said that, the fact is that the majority of those with whom we consulted clearly favoured an imputation system. So did the Select Committee, by a unanimous recommendation.

I have, therefore, reconsidered the matter in the light of this advice, and have come to the conclusion that the advantages of the two-rate system are not sufficient to outweigh the arguments that have been put forward in favour of the alternative. I therefore accept and endorse the Select Committee's main conclusion that the form of corporation tax to be introduced in this country ought to follow the imputation system set out in the Green Paper, and this is what I propose. The legislation will be in this year's Finance Bill, and the new tax will come into effect as from April next year.

I should add that in the course of the year I have been keeping closely in touch with developments in the community, which is engaged in a programme to harmonise the structure of its company taxation. It has not yet reached a conclusion, but the choice which we have made puts us in line with both France and Germany.

During the Budget debates my hon. Friend the Financial Secretary will be describing in greater detail the main features of the new corporation tax. I also thought that it would help the House, and those outside, if I were to publish at the same time as the Finance Bill a descriptive White Paper on the new corporation tax, and this will be done. There are, however, a number of matters on which it may be helpful for me to comment now.

International Companies

I have given a great deal of consideration to the position of those companies—and they include a small number of very important ones—which derive their profits and income wholly or mainly from overseas countries where the rate of tax is as high as, or higher than, it is here.

What these companies wanted was in substance a return to the arrangements, like those in force up to 1965, where the excess of a company's overseas tax on its profits over the United Kingdom tax on those profits could be used to reduce the income tax on the shareholder's dividend. I made it clear in the Green Paper that this was not an alternative which the Government would favour, and I am sure, with the benefit of a further year for reflection, that that decision was right.

In reaching this conclusion I am, once again, reinforced in my view by the Select Committee. The Select Committee did not, of course, formally consider the possibility of a return to pre-1965 arrangements; it was choosing between the two systems which the Green Paper had indicated as the real alternatives. But it gave a great deal of consideration to the problem of companies trading mainly in countries abroad with high tax rates; indeed, the Committee took more evidence on this point than on any other.

Its views were clear and again unanimous. It said, first, that …it is hard to see why double taxation relief should be so extended as to allow a United Kingdom based company not only to pay no Corporation Tax, but also to pay its shareholders net dividends on which no standard rate income tax has, in fact, been paid"; and, second, it said …your Committee on balance…plump for the imputation system with a minimum Corporation Tax charge as an essential element".

In addition to conforming with the unanimous view of the Select Committee on this point, there is another compelling reason for my decision. It is this: To give the overseas companies the relief they want would cost the Exchequer something of the order of £100 million a year, equivalent to increasing the rate of corporation tax for the generality of companies by 2.5 percentage points. The alternative would have been to have recouped the lost revenue from the general body of taxpayers.

It is right, too, to note that for most companies trading overseas, relief for overseas tax under the new system will, in fact, be more favourable than at present. Furthermore, none will be worse off, not even the companies whose only profits are earned in high-rate countries abroad.

Indeed, what these companies fear is not that they will be worse off, for they will not. What they are apprehensive about is that they will not be able to benefit as much under the new system as companies which have at least enough United Kingdom income to cover their dividends. And so they fear that their access to new capital for expansion and development may be impaired.

I believe that these fears are exaggerated; I recognise, however, that they are very real to the companies concerned. I recognise, too, that these companies play a most important part in the economic life of the nation. It is for these reasons that I have decided that, although I cannot meet their case in full, it would be right to give them some further relief for a transitional period. The present overspill payments will, therefore, be continued at their 1971–72 level for the period up to the end of 1976–77; by then we should be in a position to judge whether the companies' fears have, in fact, been realised.

For the purpose of this transitional relief I propose to leave the overspill rules unchanged with the single exception, logical under the new system, that as from 1972–73 increases in dividends will no longer diminish entitlement to overspill. This extension of transitional relief will cost £12 million in 1972–73 and £25 million for each of the four following years.


It is right that I should refer to the rate of the new tax. Because the tax will not become operative until April, 1973,it will not begin to be paid for the most part until 1st January, 1975. The normal practice, therefore, will be for the rate to be fixed in the 1974 Budget, and it will need to be determined in the light of the circumstances at that time.

This is two years ahead, and for the moment I can do no more than base what I say on the 50 per cent. rate which was taken for the purposes of illustration in the Green Paper. But I must stress that this is purely illustrative and that the actual rate cannot be fixed at this moment of time. I can, however, give the rate of advance payment as this is determined by the basic rate of income tax of 30 per cent. The advance payment of corporation tax will, therefore, be 3/7ths of the dividend paid.

Relief for Small Companies and Special Cases

I now turn to a matter of great importance—the situation of small companies under the new corporation tax. Both the Bolton Committee and the Select Committee rightly drew attention to the position of small companies which have to rely on their retained profits for a very large part of the funds they need for expansion and development. These small companies comprise a sector which is of crucial importance to the economy, and they must have every reasonable incentive to expand and develop.

I therefore propose that all companies whose profits for corporation tax purposes do not exceed £15,000 in any year will pay tax on their income at a special rate; with the illustrative rate of 50 per cent. the special rate for small companies would be 40 per cent., but I must stress again that these figures are illustrative. Notwithstanding the reduced rate of tax, any dividends paid will be treated as entitling the shareholder to full imputation credit in the usual way. There will be marginal relief for companies whose profits are between £15,000 and £25,000.

To give some idea of the significance of these provisions, I should tell the House that the full relief will be available to about 350,000 companies, which is more than 90 per cent. of all companies, and the marginal relief to a further 10,000 to 15,000. The cost will be substantial—on the basis of the figures I have taken £45 million in a full year—but well worth the encouragement which this will give to small companies.

My hon. Friend the Financial Secretary will be giving details of the way in which we propose to deal with building societies and co-operative societies, and also with certain unincorporated associations and other bodies of a broadly non-profit-making kind which have objects of a public nature.

Close Companies

I turn next to the taxation of close companies. To safeguard the Revenue there must be, and indeed there have been ever since 1922, special rules applicable to this type of company. But the 1965 legislation, when the name "close company" was coined, greatly multiplied the rules, and these have been a constant source of complaint. There can be no doubt that in recent years the rules which the Inland Revenue was bound to apply have been unduly harsh and unnecessarily burdensome.

The first point to remember is that the only justification for special rules for close companies is to prevent avoidance of tax; there is no other justification. Accordingly, my starting point is that we should retain legislation of this sort only to the extent that significant sums of revenue are at stake.

The House will recall that we said in last year's Green Paper on the reform of corporation tax that one of the objectives was to secure a major simplification of the close company rules.

One important simplification which the new system of corporation tax itself enables us to achieve is this: a shortfall assessment will in future be confined to the income tax at higher rates and the investment income surcharge. But it is right that the simplification of the system should go well beyond this. Following the relief which I gave to trading companies last year, the starting point for shortfall will again be raised. This will be done in three ways which will be explained by my hon. Friend.

All these reliefs will take effect from next year when the new corporation tax comes into force. To give the House some idea of the practical significance and extent of these changes, the result can be expressed in this way. Last year's reliefs took out of shortfall over half the trading companies which at that time were within its scope; next year's raising of the threshold will effectively take out about half of those which remain. So the combined effect of the two Budgets will be to relieve altogether from shortfall some 80 per cent. of the trading companies that came within its scope in 1970 and previous years. This represents a very considerable easing of the work burden which for far too long has lain on the backs both of companies and their advisers and of the Inland Revenue.

In total, these changes and others which will be in the Finance Bill will amount to a very substantial simplification of the close company legislation. In future it will be strictly confined in scope, easier to understand and a good deal less difficult to administer.

Capital Gains of Companies—General

I come now to the treatment of capital gains of companies, and I deal first with companies in general. The Green Paper recognised that it would not be appropriate for the rate of tax on companies' capital gains to rise in line with the increase in the rate of tax on retained profits. It therefore envisaged that the overall rate of tax on gains might be reduced by the expedient, which is administratively simple, of leaving part of each gain out of account but charging the remainder at the full corporation tax rate.

This approach was endorsed by the Select Committee, and I propose to follow it. The fraction of the gains to be left out of account will be fixed at the same time as the new corporation tax rate. If I were fixing it now, I should proceed on the basis that the effective rate of tax on companies' gains should be 30 per cent.

Capital gains of companies—Unit and investment trusts

I turn next to a matter which has been the subject of a great deal of discussion in this House in recent years—the special case of approved unit and investment trusts. Ever since 1965 the trusts have contended that they should themselves be exempt from capital gains tax. For reasons which I shall explain, I do not believe that this is the appropriate solution. Having said that, I agree that the present tax treatment of unit and investment trusts is clearly both inequitable and complex. Despite the cost, it is right that the necessary changes should be made, and they will be included in this year's Finance Bill.

The guiding principle must be that the tax on capital gains should be neutral in its impact on the ability of a trust to act as a medium of investment. The present arrangements are obviously not neutral, for the 30 per cent. rate of tax on trusts' gains may be higher than the rate which the person of modest means would have to pay if he invested on his own behalf. Equally, the arrangements for avoiding the double taxation of gains, first when they are realised by the trust and then again when they are reflected in the value of units or shares, are so cumbersome in practice that they may themselves deter investors.

So the law must be changed. But it would be a departure from neutrality simply to exempt the trusts in full, for that would give them the benefit of tax-free switching and would put them at an advantage compared with other investment media, and, indeed, with the ordinary individual managing his own portfolio.

As from April this year there will, therefore, be a new system under which gains realised by trusts will be taxable at the rate of 15 per cent. When the shareholder disposes of his ordinary shares or units, he, too, will be taxable, but in calculating the tax he has to pay he will be given a tax credit of 15 per cent. of the amount of his gain. This credit, which will not be repayable, will effectively take into account the 15 per cent. charge borne by the trusts.

The House will recall that most individuals do not pay capital gains tax at the full 30 per cent. rate on their gains; instead, they pay at their personal income tax rate on only half their gains up to £5,000 if this is more favourable. Under the new unified system next year, for those of them who are liable only at this basic income tax rate of 30 per cent., that will mean an effective capital gains tax rate of 15 per cent.

This in the case of units or investment trust shares will be wholly offset by the 15 per cent. credit on account of tax paid by the trust. The result will be that no individual on the basic rate of income tax will then have to pay any tax at all when he disposes of his units or investment trust shares; the trust will have settled the bill for him.

The new system will be much easier to understand and will certainly enhance the attractiveness of unit and investment trusts. The long-term cost will be about £30 million a year, although in the early years it may be somewhat higher than this.

Share Option and Incentive Schemes

Next, the matter of share option and incentive schemes.

In 1966 the Finance Act charged to income tax all gains from share options given by a company to its employees or directors. That legislation, as was no doubt intended, effectively put a stop to share option schemes. But, as the House knows, there has since grown up a variety of share incentives schemes under which gains to participants are liable only to capital gains tax.

I believe it is now recognised on both sides of the House that the 1966 legislation was altogether too drastic and that, contrary to the view which was then put forward by Treasury Ministers, share options have a proper and valuable rôle to play in stimulating management enterprise and in helping industry to recruit and to keep the management talent that it needs.

The Finance Bill will, therefore, contain provisions under which share option schemes which are approved by the Inland Revenue as meeting prescribed conditions will be exempted from the 1966 legislation. Gains from other schemes will continue to be charged to income tax, and so in future will gains from share incentive schemes which do not meet similar conditions. The conditions will be broadly similar to those which responsible bodies regard as necessary to safeguard shareholders' interests.

Free Depreciation

The country now stands at a moment of great challenge but also of tremendous opportunity. If we are to take full advantage of the enlarged Community market which will be opening up for us in less than a year, one of our foremost tasks must be to improve our competitiveness as a trading nation.

The hard fact is that for years now the level of productive investment in this country has been low by comparison with that of our main trade competitors. For example, in 1970 Japan invested no less than 28 per cent, of her national income. The average figure for the Six was 19 per cent. In this country it was 15 per cent.

The primary factors which determine the level of productive investment are two-fold—business confidence in a sustained growth of demand, and profitability.

A major part of our strategy must, therefore, be to provide the climate in which industry can have the confidence to re-equip and expand.

For very many years the leaders of British industry have called upon successive Governments to introduce nationwide free depreciation for all investment in plant and machinery. The problem is, of course, that to do this would remove the present taxation differential between the country in general and the development areas, where, the House will recall, I introduced free depreciation in October, 1970.

The other request which has repeatedly been made by industry is for investment incentives which are stable and easy to understand. With the opportunities which are opening up for this country, the time has now come to provide these incentives.

As from tomorrow, free depreciation—that is to say, a 100 per cent. first-year allowance—will be introduced throughout the whole country for all investment in plant and machinery, other than passenger cars, whether the investment lakes place in a development area or not.

For the sake of simplicity free depreciation will apply equally to investment in new and secondhand equipment. In other words, as from tomorrow the whole country will enjoy the taxation treatment previously reserved for the development areas.

For industrial buildings the rate of initial allowance for new buildings outside the assisted areas, which was due to revert to 15 per cent. on 6th April this year, will be increased to 40 per cent. This means that the 40 per cent. rate of initial allowance for new buildings will apply throughout the country. Again, in this respect also as from tomorrow the whole country will enjoy the taxation treatment previously reserved for the development areas. The cost of all these changes will be £5 million in 1972–73 and £115 million in 1973–74.

There will be no change in the rate of corporation tax for the financial year 1971.

Regional Policy

It will, of course, be immediately apparent that by introducing countrywide free depreciation I have removed altogether the existing taxation differential in favour of investment in assisted areas. It is our purpose, however, not merely to re-establish the regional differentials but to do so in the framework of an entirely new approach to regional policy which will give the development areas a more clear-cut preference than any previous system.

The new system of regional incentives will be simpler, more easily understood and more certain in its application than the existing arrangements. Businessmen will be able to evaluate more readily the advantages to both their firms and the country of providing more job opportunities in the assisted regions. My right hon. Friend the Secretary of State for Trade and Industry will be describing the Government's proposals in greater detail tomorrow, but the House will wish to know the main proposals now.

The existing arrangements for helping the development and intermediate areas rely heavily on the powers under the Local Employment Act to make grants of various kinds, in particular with regard to the building grants which are available throughout these areas on condition that the projects provide an appropriate amount of employment. The Government now propose, as a central feature in the renewed attack on the problems of the older industrial areas, to make building grants much more widely available. In respect of new industrial buildings started from tomorrow in the assisted areas there will be a new system of regional development grants which will not be subject to the employment condition and which will also be available, for example, for schemes which safeguard existing employment and for straightforward modernisation. The scope of these grants will be described in greater detail tomorrow by my right hon. Friend, but I should say now that they will apply to a wide range of industries in the assisted areas without their having to go through the procedures at present required under the Local Employment Act. This will speed up and also simplify the administration of the scheme.

The rate of grant for buildings in the intermediate areas and in the development areas other than the special development areas will be 20 per cent. In the special development areas it will be 22 per cent. Moreover, these grants will be on a different basis from previous grant incentives. They will not affect the recipient's entitlement to taxation relief on his investment; he will still be able to claim capital allowances on the full amount of his investment notwithstanding that part of it has been covered by grant. The separation of grants and tax allowances in this way will not only make for simpler administration; it will also make it very much easier for the businessman to see the precise margin of advantage to him if he invests in an assisted area. The value of the new grants will be substantially enhanced by the new tax basis. For a company making profits a grant of 22 per cent. is equivalent, on the old tax basis, to a grant of over 30 per cent.

Geographically, the broad coverage of the development areas will be unchanged. But there will be a major extension of the intermediate areas to embrace, broadly speaking, those parts of the North-West and of Yorkshire and Humberside which are not already included, together with those parts of Wales which are at present unassisted. This will absorb into the intermediate areas a large part of what are termed the derelict land clearance areas. The remaining part of these derelict land clearance areas will, as a temporary measure, get the same 20 per cent. building grants as the intermediate areas for a period of two years, as a once-for-all fillip to industrial renovation.

Under the Local Employment Act the development areas, though not the intermediate areas, get other forms of assistance to industry. It is necessary to restore and reinforce the differential treatment of the development areas in a way which best meets their present need both for more enterprise in existing industries and for new firms and industries capable of seizing the opportunities provided by the European market. There are opportunities in these areas for foreign firms as well as British. These are powerful reasons why our incentive system needs to be simple to understand and capable of offering advantages to newcomers as well as to established firms.

The Government have, therefore, decided that in the development areas alone the grant scheme should be extended to plant and machinery on a basis closely related to the arrangements for building grants. The rate of grant for capital expenditure incurred on new plant and machinery from tomorrow will be the same as for building grants—thatis, 22 per cent. in the special development areas and 20 per cent. in the rest of the development areas—and the scheme will be on the same new tax basis.

As in the case of capital allowances, the cost of these grants will depend on the level of qualifying investment, and actual payments fluctuate a good deal. Subject to that, the estimated additional expenditure in the development and intermediate areas is approximately £200 million in the first full year.

These general schemes will be supplemented by continuing selective assistance in the areas of high unemployment on the lines of the loans and special grants hitherto provided under the Local Employment Act.

The measures which I have announced—free depreciation and new measures for the regions—together provide the most powerful combination of national and regional investment incentives which we have had in this country since the war. Moreover, in order to give industry the stability it seeks when planning long-term investments I should make it clear that the intention is that the new system of investment incentives—[Hon. Members: "Grants."]—including free depreciation, should endure at least until the end of the E.E.C. transitional period; that is, to 1st January, 1978.

The object of these measures is twofold: first, to stimulate investment and modernisation and so to help industry to equip itself to compete more effectively in the Common Market; and, second, to make a new and intensified assault on the deep-seated problem of regional imbalance, which involves so much hardship and waste of resources.

The House knows my views about the regional employment premium. The previous Administration undertook that it would continue until at least September, 1974, and that there would thereafter be no question of abrupt termination of the scheme. In our manifesto we said that we would phase out R.E.P. taking proper account of existing obligations and commitments. That will be done, and R.E.P. will accordingly be phased out over a period from September, 1974. The rate and method of phasing out will be announced in due course in the light of the circumstances at the time and after consultation with industry.

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