ISSUE OF VALUE ADDED LOAN STOCK (Hansard, 9 July 1985)

§ Sir Brandon Rhys Williams (Kensington)
I beg to move, That the clause be read a second time.
I have been encouraged by the welcome I have had in past years for proposals of the same kind to believe that this proposal once again is worth a few minutes of the time of the House.
1040 I have often sought to draw the attention of the House to the paradox in the capital market that, on the one hand, we have lenders not short of funds who complain that they cannot find suitable borrowers and, on the other, a large number of corporate borrowers who cannot get offers of finance on terms which they feel able to accept. So we have an unsatisfactory situation in regard to investment in the private sector; many companies have first-class schemes which are postponed from year to year because capital market conditions do not seem to the management to be quite right — so they postpone their project from one year to the next.
The reason is not that there is something wrong with the lenders or with the borrowers but that the structure of the capital market as it now exists in London is too limited. In particular, we tend to look at projects over much too short a term. Investors and borrowers cannot see far enough into the future as perhaps they were better able to do under the gold standard; so the returns on an investment have to be very quick if it is likely to find support. Big profits are needed in the early years. After that, what happens to the investment is a matter of relative indifference to both sides. That state of affairs does not show capitalism at its most fruitful. It ought to be a matter of serious concern to the Government to lengthen the time span of discretion in corporate finance.
Investment yielding a slow start in the early years, even with lively prospects in the long run, cannot get finance on terms which are acceptable to the parties. This is something that must be remedied and I think the remedy lies in minor reforms of the tax system, at any rate to a certain extent. I know it is dangerous to generalise, but perhaps it is worth the House considering the comparison between the present difficulties of raising finance for the Channel link, which is bound to be a success in the long run, but could well be a slow starter in terms of producing returns, and the Suez Canal, where Disraeli was able, I believe, to find money on 99-year terms with no difficulty when he went out to buy the shares.
Can we do something about this state of affairs? The risk of inflation makes fixed-interest borrowing very dear for companies in real terms in the early years. Convertible debentures do not solve any of the problems, although they have a certain use, no doubt. Deep discount, which the Government believe in and have made possible, is a gamble on inflation, with a winner or a loser according to whether the terms are right or wrong for the company which raises money in this way. That is not an attractive way of raising capital for very many solid and responsible managements and deep discount is not going to catch on in a big way. Equity issues put directors at risk because their profits may be diverted away from the remuneration of the investors, which they have offered in the original prospectus, by all sorts of forces over the passage of time. Current real rates of return are not high enough in many sound businesses for them to justify an issue of new equity stock, and so we drift on from year to year. Investors tend to buy existing assets rather than participate in new ventures, and that is an unhealthy and inflationary aspect of the capital market. We see it in the price of parades of shops and other properties, such as houses in Kensington, which constantly go up in price as funds look for places to rest.
Before I came to the Chamber, I turned up a copy of The Times for 1935, because I thought that it might be instructive to look at the page showing stock exchange 1041 prices and the active dealings that took place in July of that year. I do not want to weary the House, but I can give some examples that leap to the eye. One of the sections that was quoted was the home railways section, which was divided into the ordinaries, the debentures, the guaranteed and the preference shares of the railway companies. That shows the range of opportunities available for corporate finance.
I looked up Imperial Chemical Industries, for which I had the pleasure to work for 14 years. It had ordinary shares in active issue being traded all the time, ordinary deferred issues and the 7 per cent. prefs, all of them active in the market. Harrods had an ordinary issue and 7.5 per cent. prefs. Imperial Tobacco had ordinaries, 5.5 per cent. prefs, 6 per cent. prefs and 10 per cent. prefs, no doubt issued at different times, but all of them actively traded in the market. GKN had ordinaries, 5 per cent. prefs, 5 per cent. second prefs and 4 per cent. debentures.
The structure of the stock exchange quotations for the standard, well-known British companies do not now have that range of different instruments by which the boards were able to raise finance in those days. In 1985, however, the Government do have this option, in that they can issue fixed-interest stock, which yields about 10.5 per cent., or indexed stock at 3.5 per cent.—about one third of the cost in terms of the initial real dividend for stocks of 20 years' duration. The cost over the life of the loan to the taxpayer in real terms may be the same, but the cost in the early years is much less, as only one third is going out in dividends for the same initial capital.
Private sector borrowers do not have this option. If they are going out to the market on fixed-interest terms, they have to pay something that goes beyond the fixed-interest terms offered by Government stock — that is to say, a very high real rate of interest in the early years, and then an unpredictable burden on the company as the years go by, because no one can see what inflation will do to the commitment to service a new debenture issue over a long span of time.
Private sector borrowers therefore believe that they cannot enjoy a similar option to the Government in issuing long-term indexed stocks such as would enable them to raise money at much lower cost in the early years. They may be misinformed. My hon. Friends have suggested that the changes in the tax system of companies in recent years has opened the way for such issues. People to whom I speak however, who are experts in that sector, do not believe that this is the case. If the market is unaware of the opportunities or doubts whether they exist, we are not likely to see companies making use of this facility.
If companies were able to issue indexed debentures in the same way as the Government, should they, prudently, use the RPI? I doubt whether it would be wise for companies to make the same commitment as the Government, and to bind themselves to meet changes in the RPI from year to year whatever they might be. If there are sudden changes in the RPI, there might also be sudden changes in the climate for business which would be adverse to the firm, and which would not necessarily leave it in a position to raise its dividend along with the RPI.
The RPI is something like goblin fruit: it looks very good, but in time it could poison one. It would be better for companies which want to enter the indexed market to devise a formula which would relate their dividends to the company's turnover, or to its value added, or to its annual achievement in one form or another, so that as the years went by, the commitment, which would be a prior charge, 1042 would be within the capacity of the company to meet. The commitment would be ruled by the company's own performance and the investor in this type of stock would be participating in the performance of the company. It would be different from an equity, in that it would not be a discretionary dividend: it would be a genuine prior charge. The terms of the loan would be fixed from the start, and that would be made perfectly clear in the prospectus. It would be different from a debenture in that it would protect the investor from depreciation in the currency year byb year, because the calculation of the amount to be paid would be made in the currency of the year in which the profit and loss account was decided. It would be different from bank debt, because it would contain an element of participation in the firm's performance.
If it is true that the annual charge for service of an indexed loan would rank as a prior charge for corporation tax as my hon. Friends have been trying to explain to me—or if it did not greatly matter if it did or not, because of the reductions which have been made in the taxation of companies — we would still have the problem of the treatment of the eventual capital repayment. It would be unsatisfactory for the capital not to be indexed on the same or similar terms to the dividend. Obviously, it must be indexed in a way which does not introduce an element of discretion and I have tried in the new clause to suggest a way in which the discretionary element would be minimised. No doubt there are many other ways.
If the eventual capital repayment were twice or three times the numerical amount of the original loan, how do we treat that excess for tax purposes? I suggest that, up to the amount of the increase which corresponds to the increase in the RPI, the repayment should be free of tax. In so far as it exceeds or falls short of that, it should be taken into the tax liability of the recipient as a capital gain or loss. For the company, the repayment of the loan on the terms on which it was originally issued, must surely rank as a prior charge.
I realise that there are opportunities here for tax evasion, but my right hon. and hon. Friends are equal to overcoming that problem. I hold the belief that where there is a will there is a way. At the moment, this type of loan stock is not known at all, but if the tax position were clarified, it would gradually become an important element in corporate finance. Why not give it a chance? If companies do not want to use the facility, nothing will be lost, but if it is found to be a useful instrument for expansion, it must surely be worth making the effort to make the correct and necessary adjustments in our company taxation system.
The Government need not fear a loss of revenue, because a healthy private corporate sector must be good for the overall yield of tax. The Bank of England need not fear that private borrowers would crowd out the Government in the indexed market, because the supply of this type of stock would tend to create its own demand, as the market became used to its existence.
Existing equity holders would not suffer, because if a company's investment brought a good return, it would more than service the debt and provide an additional source of finance for increasing the equity dividend as well. We should not think only of the advantage to conventional corporate borrowers, but should look slightly wider to the facilities that the London capital market ought to be offering. This type of facility would open the way 1043 to companies without equities. This is becoming an important element in the London capital market in the form of management buy-outs. It is a development which deserves the Government's fullest encouragement. Management buy-outs—or companies without equities—provide the Compromesso storico between capitalism and Marxism, where the profit belongs to the workers but there is a fair return to the investor too.
Investment under Islamic principles is also being sought for a large volume of funds. It would be a particular advantage if there were in London a range of stocks that were eligible to attract investment from owners of funds who have reservations about interest and want the yield from their investments to be characterised as a share in the profits rather than as a usurious exaction.
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I also stress the advantage of the existence of a body of stock of the type that I have in mind to private pension funds. They want long-term inflation protection, are looking for some participation and are not attracted by the ups and downs in the casino of the stock exchange which has lately suffered such unpredictable changes and is geared to short-term considerations.
I hope that the idea behind my new clause will find support in the Government and that Ministers will continue to study my suggestions. I trust that they will see the value of widening the opportunities of obtaining corporate finance in London in this way, and will make the necessary changes in the impact of taxation.

§ Mr. Blair
The hon. Member for Kensington (Sir B. Rhys Williams) has correctly identified a problem, but I am not sure that I fully support his proposed solution.
The hon. Gentleman rightly said that there is a difficulty in borrowers getting finance at acceptable rates of interest and that the structure of the capital market is too limited and funds are provided for too short a term. Indeed, those are frequent complaints of the Opposition and they prompted many of the considerations that led my right hon. Friend the Member for Birmingham, Sparkbrook (Mr. Hattersley) to propose the establishment of a national investment bank.
I should like to make sure that I have understood the ingenious scheme proposed by the hon. Member for Kensington. It would allow companies to raise money by issuing loan stock, and the interest paid would not be treated as a dividend under section 233 of the 1970 Act, but would be allowable for the calculation of corporation tax and computed in accordance with a formula related to company performance.

§ Sir Brandon Rhys Williams
indicated assent.

§ Mr. Blair
I am pleased that I understand it. It is a peculiar type of stock, almost a hybrid. Interest payments are normlly treated as a straight deduction from profits, whereas the dividend would be subject to ACT. If a loan stock certificate for, say £1,000 were issued, interest would be payable, but it would be calculated on a basis that took into account the profits of the company within the five accounting periods laid down in the new clause.
I hope that the Economic Secretary will tell us whether that would give a favourable tax treatment for this type of share. It must surely have an impact on corporation tax 1044 revenue. The hon. Member for Kensington has done us a service in raising the issue, but there may be better ways of dealing with the problem that he has identified.

§ Mr. Ian Stewart
I compliment my hon. Friend the Member for Kensington (Sir B. Rhys Williams) on raising this interesting subject. He has commented on the problems of matching borrowers and lenders, and suggests in his new clause an interesting and novel concept, which may assist companies with some problems in raising the type of money which they need and which investors will be happy to provide.
The new clause aims to ensure that interest paid on this special loan stock will be given a deduction in the same way as that paid on a bank loan, rather than treated as a distribution. I say that the clause "seeks" to ensure that payments will be treated in that way because in most circumstances that is already the case. Section 60 of the Finance Act 1982 provides that where in various circumstances interest paid is related to the company's performance and does not exceed a reasonable return, it will be treated as a deduction in the ordinary way. In the circumstances to which section 60 apply, the results which my hon. Friend seeks are already achieved.
If the principal of the loan were to be indexed to the retail price index — one of my hon. Friend's ideas — there would be a capital uplift on repayment, apart from on interest, which would be a capital item for both borrower and lender. In other words, the borrowing company could not obtain a deduction for the uplift, but the lender would be effectively exempt from tax because in most cases he would be covered by the indexation provisions. If the value added were in terms of the company's performance, an uplift would probably be treated as a distribution, subject to the provisions of section 60. In those circumstances although ACT may be payable, a deduction would be available against the company's ordinary corporation tax liability.
Since the indexation of CGT for assets without a one-year waiting period was introduced, if a company could get a tax allowance on the index uplift of borrowing, but was tax free on the disposal of an asset which had risen approximately in line with the RPI on the other side of the balance sheet, it would get double tax relief on the same increase in value. Therefore, I cannot give much encouragement that the Government will make the sort of tax regime for which my hon. Friend asks for index borrowing or other forms of borrowing where there would be a capital uplift which could be offset in part against a protected gain on the asset side of the balance sheet. I need to study the question more deeply, and to write to my hon. Friend on his technical points.
Taking into account our proposals on deep discount securities, we have ensured that companies will have considerable scope to draw on various borrowing instruments, including, with the CGT changes, index linked borrowing. I shall study the points raised by my hon. Friend, and thank him for having given us an opportunity to discuss these questions. I hope that in the light of those comments he will ask leave to withdraw the motion.

§ Sir Brandon Rhys Williams
I thank my hon. Friend for his helpful remarks. I recognise that the new clause, which is precisely the same as the one which I tabled three years ago and which also gave rise to a useful debate, is 1045 defective and is not even a precise expression of what I now see as the desirable objective. I hope that on another occasion wee shall go further into the subject. I beg to ask leave to withdraw the motion.