New Clause. — (Assessment of Profits for Income Tax, etc., Purposes.)

Orders of the Day — Finance Bill – in the House of Commons at 12:00 am on 6 July 1949.

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Where any person carrying on any trade profession or business (not being a company or corporation) or the whole of the partners in any partnership firm carrying on any trade profession or business give to the Commissioners of Income Tax notice in writing of his or their desire to avail themselves of the provisions of this section then in respect of the first normal accounting year in relation to such person or firm commencing not less than twelve calendar months after the date of such notice the profits of such person or firm shall be assessed for Income Tax and Surtax purposes on the basis of the fair three years average of the profits of such person or firm in such next first normal accounting year of such person or firm hereinbefore referred to and the two normal accounting years immediately preceding such next first normal accounting year and the profits of such person or firm shall continue to be so computed in every subsequent year of assessment on the basis of the fair three years average of the profits of such person or firm computed on the appropriate normal year and the two years next immediately preceding the same until the expiration of twelve months notice in writing given by such person or by all the partners in such firm such notice to expire at the end of a normal accounting year.—(Mr. Hale.)

Brought up, and read the First time.

Photo of Mr Charles Hale Mr Charles Hale , Oldham

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

This proposed new Clause is a sincere attempt to bring to the attention of the House a very genuine point, which I promised the Committee when they were considering this matter that I would try to cover by a draft, so that it could be brought up for discussion and consideration.

The problem to which the Clause is directed is that of the man with a fluctuating income; and that income can fluctuate for many reasons. There is, ofcourse, the familiar problem of the writer, or the distinguished theatrical star, who may spend many years of earnest endeavour on small salaries and then enjoy a temporary, possibly even an ephemeral publicity, afterwards reverting again to the lower income grades; but during that time he has to pay in full on the high income which he may enjoy for a limited period. I remember discussing the matter with a very well-known radio performer who is still living, and so I will not give any indication of his name or his particular financial situation. He said to me, "I give myself about five years, and in those five years I have to make provision for my wife and children. You, Leslie, if you are lucky, will have 25 years for the purpose." That has always seemed to me to be a point of real importance and hardship.

There is another quite different aspect of the matter. Distinguished members of my right hon. and learned Friend's own profession, if rumour—always a lying jade—may be temporarily credited, do at times attain quite substantial incomes, but they may frequently be called upon to perform important public service for which they receive no remuneration. A distinguished member of the Bar may be asked to go abroad to preside over some commission for six months; or he may have a temporary appointment in the Services. A member of the Bar has no continuity of income even of the type which I enjoy. While he is abroad his income has gone completely, and when he comes back he may find difficulty in regaining it. The result is that in one year he may enjoy a very large income and in the following year he may see that income temporarily disappear, it may well be to recur a year later.

6.0 p.m.

The problem becomes much more acute in the days of modern taxation when, of course, the higher rates of income are very heavily taxed. I took, for experimental purposes, the case of the married man with no children whose income is wholly earned. On an income of £2,000 a year, he would today pay in Income Tax a sum of £594. In other words, on the whole of his income he would pay at a rate a fraction less than 6s. in the £. On an income of £10,000 he would pay £6,381, or at a rate, on the whole of his income averaging it out, of just under 13s. in the £. On the middle figure of £6,000 he would pay £3,181 10s. Of course, I am including Surtax in these figures. The House will readily understand that, because it is in respect of Surtax that this matter would primarily apply.

This is not a new proposal. It was in the Finance Act of 1842 that the three years' average was brought into force, and that average then applied to all incomes. In those days taxation was so small that the importance of this procedure was not very specially manifest. The system was amended in 1856. Under the then law it was possible for the Income Tax payer either to pay on a three years' average or on the actual figure, whichever was the lower. That clearly gave the Income Tax payer a most unfair advantage, and that practice was criticised for many years. It was criticised in the Departmental Committee on Income Tax of 1905 and by the Royal Commission of 1920. It was acting on the criticism of the Departmental Committee and the Royal Commission that in 1926 the three years' average was abolished by the right hon. Member for Woodford (Mr. Churchill) when he was Chancellor of the Exchequer. The alteration came into force in 1927.

There was much force in the removal of the three years' average as it then stood. The main criticism against it was directed at the option it gave that one paid on the lower of two figures. Therefore, I have tried to draft a Clause which would bring before the House the real need for this average and which, at the same time, would try to give to the Treasury protection from the exploitation which the previous proposal involved. The Clause as drafted provides, first, that it shall only apply if the taxpayer—or, if it is a partnership, the whole of the partners—give 12 months' notice in advance of their intention to avail themselves of the Clause.

The reason for that provision is that it would be unfair to say to the musical artist, the radio star or the distinguished counsel that they could wait until this happened and then say, "I am doing so well that it will now pay me." If a man feels that he belongs to one of these comparatively rare professions whose incomes fluctuate so violently that it will be hurt by this state of affairs, then he must give 12 months' notice. Equally, I have provided that once notice has been given, it can only be terminated on 12 months' notice.

The House will bear in mind that there is another aspect of importance. I speak with a certain amount of feeling on this matter. The right hon. and learned Gentleman will know that Surtax is paid in arrear and it is on one's income for 1947, for example, that one finds oneself levied for payment of Surtax on 1st January, 1950. It can be a very real hardship if the prosperity that one thought might continue is not continuing, to find that one is called upon two years later to pay an amount which might well be twice the total income which one derives for that year.

Speaking as a fairly obscure professional man whose income is not so high that he has much to gain by this, I will say that my income has fluctuated in the last five years to the extent that the highest figure is three times the lowest figure. I am speaking for many professional men when I say that that is inevitably the position. I am not seeking for anyone any reduction in the taxation that be should pay. All I seek is that each year it be averaged out, so that he pays on the real level of his income and is not called upon to pay on the top rate, at a singularly high figure, when he may find the next year that his income has dropped to the extent that he really cannot pay. Circumstances such as this have brought about real hardship.

I do not underestimate the administrative problems which this proposal involves. But in these days, the accountant, the auditor, indeed the Income Tax adviser, has become almost an essential to every business or almost an essential to every business or professional man. In many professions, including my own, there is a statutory obligation to have accounts audited. There is a statutory obligation to comply with accountancy rules. Therefore, the accountant's certificate is available and the administrative difficulties are much less than they would have been 20 or 30 years ago when the auditor or accountant did not play such a prominent part in the lives of professional and business men.

In drafting this Clause, I have tried to take into account all the difficulties. I have tried to draft it in such a way that it would not make possible any exploitation. I bear in mind, too, that it is being introduced at a time when it will have the least harmful effect upon the Treasury and the least beneficial result to the taxpayer, because the normal expectation—an expectation reinforced by the speech we heard from the Chancellor today—is that on the whole the tendency will be for the general level of incomes to diminish. Therefore, there is not the benefit that might be derived if there were a prospect of expanding incomes.

I have put the Clause down in as fair a way as possible, to try to remedy some of the complaints voiced from time to time in the columns of the Press and in the meetings of professional, learned and other societies. I have tried to meet a problem, which I think is one of importance, in such a way that no one would get any unfair advantage at all, and I have tried to provide that people in future shall pay tax upon their real and effective income and not upon the fluctuations which would cause them harm. I do not think that it is necessary for me to elaborate the matter further.

Photo of Mr Francis Bowles Mr Francis Bowles , Nuneaton

Does any hon. Member wish to second the Motion?

Photo of Lieut-Commander Joseph Braithwaite Lieut-Commander Joseph Braithwaite , Holderness

I beg to second this Motion.

As we are on the Report stage and as this new Clause requires a seconder, none apparently being forthcoming from the Government benches, I should like to say that the hon. Member for Oldham (Mr. Hale) has made a proposition of considerable value. I read his Clause on the Order Paper and I imagined its purport to be as he has explained it to us. There is no doubt at all that if anything can be done to iron out the sharp fluctuation of tax assessments, it would, as the hon. Gentleman said, be of value to a great many professional people. I note that he has very properly I think, narrowed his exemptions to persons engaged in a trade, profession or business. He ignores companies and corporations. Therefore, the new Clause will deal with that section of the community which is most affected. Unless we hear from the learned Law Officer that there is some flaw in the wording or drafting, the intention seems to be clear enough. Whether the wording has the result which the hon. Gentleman has in mind is, ofcourse, for the legal adviser to tell us. If it is the case that this Clause is sound in its drafting, there is no doubt at all about the soundness of the proposal before us.

Photo of Mr William Brown Mr William Brown , Rugby

I want to support this new Clause by reference to Governmental practice in another connection. The other night we were discussing in this House the new regulations governing the pensions of police officers. One Clause of those regulations provided that, when a policeman was promoted during the last years of his service, his remuneration for the final three years of his period of service should be averaged for the purpose of determining the pension which he was to be paid.

Photo of Mr Douglas Houghton Mr Douglas Houghton , Sowerby

The pension then payable was payable for life.

Photo of Mr William Brown Mr William Brown , Rugby

I know, but the point behind the Government's support of those regulations was that it was unfair to burden the State for a long period of time after a man's retirement with a pension which was sharply inflated because of his promotion during the last few years of his effective Governmental service. The Government took the view, and I am not arguing against it, that when we are paying out State money, we should try to avoid sharp extremes up and down, but average the remuneration and determine the liability of the State by reference to it. If that principle is operative in paying out State money, it ought also to be operative when the State is taking money from the citizen.

As things are, I do not think there is one of us who could not confirm what the hon. Member for Oldham (Mr. Hale) has said in regard to professional men being embarrassed to a very great degree by the circumstance that their earnings are very often sharply uneven, and by the circumstance that heavy taxation, indeed ordinary taxation, is collected heavily in arrear. Indeed, it is difficult to get the Government to give one an up-to-date assessment of one's tax indebtedness for a long time after the liability has been incurred. I am quite sure it is the experience of every one of us that we are continually dealing with tax matters two or three years late, not because people want to dodge their tax liability, but because the Revenue machine is overworked and certainly understaffed. Certainly the collection of taxes is heavily in arrears. When ordinary Income Tax has to be cleared up first before a start can be made on Surtax, the Surtax is still more heavily in arrears, and a man is often confronted with a demand for a large sum of money relating to a high earning capacity in one year and not subsequently repeated. That may happen at a time when his earning capacity is at a minimum and he is being taxed on the maximum, which may cause him very grave embarrassment indeed. If it is administratively possible to work this new Clause, I heartily commend it to the Government.

Photo of Sir Frank Soskice Sir Frank Soskice , Birkenhead East

The hon. Member for Rugby (Mr. W. J. Brown) drew an analogy between the police regulations and the new Clause which is now being discussed, which I do not admit. If, however, there is an analogy between the two cases, the force of his argument is taken away by this consideration, that, broadly speaking, the system now proposed has already been tried. It was tried and abandoned in 1926, and it was abandoned largely because it was found that on balance the system then in force of the three years' average imposed more hardship upon the taxpayer than the system which was adopted in its place, which is the present system now being operated, in which the taxpayer under Schedule D pays tax on the accounting year ending in the previous year to that on which he was assessed. That will be my principal reason, but I think I can give other reasons for saying that it imposes great hardships.

6.15 p.m.

The taxpayer finds himself in considerable difficulty when there may be a sudden fall in his profit in the third year, when he pays on an assessment which is based upon the much higher rate of profits which emerges from the average rate of the three previous years, and is more than he would have to pay if he were to pay simply on the earnings of the previous year; that is to say that, in the three-year period, the rate of profits over the three years may be much higher if profits were falling than it would be if he was paying on the previous year's profits.

When that system was in operation there was considerable complaint, and taxpayers said that they were faced with great difficulties because, when profits were falling, instead of being able to pay on a comparatively low rate of profits, they had to pay on a much higher rate which emerged from the average of the previous three years, and that was one of the main reasons the previous system of the three years' average was abandoned. My hon. Friend shakes his head, but I am informed that that really is the case, and, if he will forgive me contradicting him on another point, I think he will find that he is mistaken if he will look at the Income Tax Act, 1918, in which he said there was an option. There was no option then; it was payable on the previous three years by Statute.

My hon. Friend gives an option in his new Clause, but I do not think that it will make the slightest difference to the consideration which I have just urged—the fact that the previous system produced hardship in a time of falling profits. He now provides that 12 months' notice should be given for the taxpayer to avail himself of the provisions of the new Clause. Even under his system, the advantage would be lost, because, where the taxpayer found that his profits were falling and he gave notice, a period of 12 months would have to elapse before the new system could operate, and he would find, until that 12 months had elapsed, that he still had to pay a much higher rate—the average for the previous three years—than he would have to pay if he were taxed on the previous year, as he is at the moment. Exactly, the same difficulty would arise as that which led to the abandonment of the old system.

Photo of Mr Charles Hale Mr Charles Hale , Oldham

Will my right hon. and learned Friend allow me? Is he not making a false point in this matter? If I take the case of a member of the Bar, a man of 60 would not give notice, because he would have a reasonable probability that his income had reached a stage at which it would begin to go down, and he then has that option. There is really nothing in the point which he is making. It is quite clear that, if we average a continually diminishing income, he would pay a little more, whereas if we average a continually growing income, the State would take a little less.

Photo of Sir Frank Soskice Sir Frank Soskice , Birkenhead East

The answer to that is that this deals with non-company taxation and not only members of the Bar, and therefore large numbers of taxpayers whose profits go up and down are to be given a 12 months' interval in which to switch from the three-year period to the provision now proposed, but they will very soon find themselves in difficulties—the same difficulties in which taxpayers were placed before 1926, when the previous system was abolished. The system was in fact tried, and on balance was found to be wanting. It imposed more hardships upon the taxpayer than the present system does.

What is the intended virtue of the present system? It is that the taxpayer is taxed on the previous years' earnings and on the accounting year which ends in the year previous to that in which he is paying tax, and the virtue of that is to try to relate the actual earnings to the amount of tax he has to pay. This only applies in cases of assessment under Schedule D, and does not apply to Schedule E taxpayers. Generally speaking, we have to look for some completed trading period to tax. The present legislatsion says that we will try to get the trading year which is nearest to the year on which a man is actually being taxed; in other words, we will try to ascertain his position for tax purposes at a period nearest to the actual year in respect of which he is being asked to pay tax. That is the aspect of the matter so far as the taxpayer is concerned.

So far as the Revenue is concerned, the system which my hon. Friend seeks to introduce has undesirable features. It does, after all, introduce something of an element of a gamble. When profits are rising and we are in a buoyant period of trade, then, I suppose, there will be a tendency to rush to the three-year average method of computation. Conversely, when there is a period of falling profits, I suppose there will be a rush back, so that there will be a perpetual bet between the taxpayer and the Exchequer. The taxpayer will be assessed on his earnings according to whether his bet turns out to be justified or not. That is not a desirable principle on which to assess tax liability. There is that obstacle, and there is also, if one looks at the actual form of the Clause, the objection that it would enable a taxpayer to take a year of poor trading, when he made very low profits, into account twice over for the purpose of assessing his tax liability.

Supposing he gives his notice of year one, then year three, under the Clause as drawn, will be the first normal year, and in year three he will be taxed on years one, two and three. If year one is a bad trading year, it will be taken into account for that purpose. In year two, as his notice given in year one will not become operative, he will be taxed on the existing principle, namely, on the preceding year's earnings, so he will have the advantage of getting his low profits in year one taken twice into consideration. I have no doubt that my hon. Friend and hon. Members opposite will admit at once that would not be fair to the Revenue.

This is a matter of considerable difficulty and I am perfectly conscious of what my hon. Friend says with regard to the person who, having worked himself up into a position of considerable eminence in a profession, the arts, or whatever it may be, suddenly finds that he has a substantial tax liability because he is reaping the advantage of the eminence to which he has attained. It is a very difficult problem and if I might say so, as I have with regard to a number of previous Clauses, it is a matter with which the Tucker Committee will concern itself.

I ask the House not to adopt the Clause. It is based very much on the principles applied before 1926, the principles which were then abandoned. It really faces the taxpayer with precisely the same hardship as marked the pre-1926 system, and it is obviously one of the matters which must first be reviewed by the Tucker Committee. The Clause is defective in point of machinery, for the reasons I have given, and therefore I hope that the House, taking all those considerations into account, will agree that it cannot be adopted in its present form.

Photo of Mr Ralph Assheton Mr Ralph Assheton , City of London

The right hon. and learned Solicitor-General has given the House a very careful appreciation of the Clause moved by the hon. Member for Oldham (Mr. Hale). I think that everyone who listened to the speech of the hon. Member for Oldham had a great deal of sympathy with what he was driving at. He pointed out how hard it was in many cases when a man who had a fluctuating income found himself paying a heavy rate of tax in a year in which it so happened that his income was very much lower than in the year in which he was assessed.

The Solicitor-General told us that under the law as it stood before 1926, there was a provision for basing assessments on a three-year average, and that that system had been abandoned because, on the whole, it did not suit the taxpayer. I am not quite sure whether that was the reason or not, but at any rate, abandoned it was. Since then many hardships have fallen on the taxpayer in consequence of its abandonment. It is true that there may have been advantages to the taxpayer as well, but there have been hardships. I wonder whether the Solicitor-General will agree with me that the very greatly increased rates of tax have made a great deal of difference to this problem. In the days prior to 1926, the rates of tax were much lower than they are today, and consequently the whole pressure on the taxpayer was not nearly so severe.

I will give the House one short illustration of how very unfairly the present form of taxation can work. It is an illustration which was given to me the other day by a valuer who, at the moment, is extremely overworked, engaged as he is in valuations under the Town and Country Planning Act. There may be hon. Members in this House who are themselves in that position at the moment. He told me that at the end of five years he is likely to receive a very substantial fee, which he estimated to be in the nature of £10,000, as a result of five years' hard work. Although for five years he will be working on these valuations, his reward will not come to fruition until the end of that period, when he will receive £10,000 for the work done. As he already has a substantial business, it means that that £10,000 will come on top of his normal income, and he anticipates that, in fact, he will receive less than £1,000 as his reward for that £10,000 worth of work.

I know that the Solicitor-General is fully aware of that sort of thing, and I am very glad to hear that the Tucker Committee is to consider this problem. In the light of the hon. and learned Gentleman's speech, and in view of the fact that he told the House that the Tucker Committee is going to consider the problem, I dare say that the hon. Member for Oldham will not seek to press his Clause to a Division. Whether he does or not, I should like to assure him that we on this side of the House have a good deal of sympathy with the object underlying it.

Question put, and negatived.