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Close Companies (Interest Payments)

Volume 977: debated on Tuesday 29 January 1980

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11.2 pm

I beg to move,

That the draft Income Tax (Excess Interest As Distributions) Order 1980, which was laid before this House on 14 January, be approved.
This order increases from 12 per cent. to 17 per cent. the limit enshrined in section 285(4) of the Income and Corporation Taxes Act 1970.

The House will recall that if a close company were to pay interest to a director who had a material interest in that company—roughly defined as 5 per cent. or more of its equity—or to the associate of a director, and if such interest is in excess of the prescribed limit, the excess is to be treated as a distribution with disadvantages, to which I shall refer.

First, the company will not be able to deduct that excess as a charge on income for corporation tax purposes. Furthermore, the excess will be subject to advance corporation tax. The original measure, which contains the first limit, dates back to 1965 and was designed to evade what was then thought to be a possible measure of avoidance whereby directors and their associates would suck out of the companies in which they were interested, by way of interest, sums that would more properly be regarded as distributions or dividends.

In 1969 the limit was 8 per cent., which related to a bank rate of 8 per cent. In the Finance Act 1974 it was raised to 12 per cent., to keep it in line with a bank rate of 12 per cent. Now that the minimum lending rate is 17 per cent., it was thought appropriate—I hope that I shall carry the House with me on this—that the limit should be raised to 17 per cent.

That is a different question, to answer which would take me into fields of economic policy that it is not appropriate for me to debate now, though I am always happy to debate with the right hon. Gentleman, who has profound knowledge. Indeed, he perhaps has more experience than I have. He sat for many years in the room that I am now privileged to occupy at the Treasury.

Those are matters that lie outside this modest order. It does no more than to adjust the limits that previous Governments, of whatever complexion, thought should be adjusted to keep them in line with the prevailing minimum lending rate and bank rate. I hope that on that basis the House will feel able to approve the order.

11.6 pm

The Minister of State has not dealt at all with the reason why the rate is going up from 12 per cent. to 17 per cent. We all appreciate the technical reasons for the order—that from time to time the rate must be examined, because money paid out of a close company can sometimes be dressed up as interest instead of being a distribution. We understand that quite well. But the question to which the hon. and learned Gentleman should have addressed himself—and did not—was the reason why we are being asked to increase the rate to 17 per cent.

The Minister said that it was not within his province to answer that question. However, it is the very reason for the order. If it were earlier in the evening, and more hon. Members were present, perhaps the hon. and learned Gentleman would be pressed more on the question why the order is being introduced. Why is he wasting the time of the House if there is no particular meaning to the increase?

The Minister knows very well what the reason is. He tried to ignore it, but it clearly is that this Government, through their economic and financial mismanagement, have created a situation in which we now have a minimum lending rate of 17 per cent. The hon. and learned Gentleman himself said that the rate required for this rather technical order generally followed bank rate or the MLR. It is now following an MLR of 17 per cent., which has been created by this Government.

It is only right, even at this late hour, to make it quite clear that we are being asked to increase the rate to 17 per cent. because of the inflationary effects of the Government's policy. I repeat what we have said before in the House, that the main reason for our high interest rates is not technical, having to do with monetary targets and borrowing requirements, although they are subsidiary to it. The main reason why we are being asked to sanction an interest rate of 17 per cent. is that the Government have deliberately put up inflation since they came into office by at least 8 per cent., and perhaps even more. Before long, inflation will be running at 20 per cent.

If we have an inflation rate of 20 per cent., we cannot have an MLR much below 20 per cent., whatever theories, philosophies and views we have about monetary targets, monetary control or anything else. The two must go together.

This little order is a by-product of the Government's financial mismanagement—their deliberate abrogation of their primary duty to control inflation. Instead, they have taken deliberate measures to put up the rate of inflation. That has put up interest rates, with the result that we are being asked to pass an order to change the rate in this technical area from 12 per cent. to 17 per cent.

The other reason, subsidiary to the inflation point, is that the Government, having put up inflation deliberately, as I have described, reduced the monetary targets. We have inflation going up and the monetary targets coming down. With the need to sell Government stock and to control bank lending, interest rates must inevitably be higher, and now we are suffering a 17 per cent. MLR.

It is instructive to note that we are concerned here with close companies. This is a technical taxation point. Most close companies are merely small private companies. They are the kind of small businesses that hon. Gentlemen on the Government Benches were championing in Opposition, but now, in Government, they seem to accept with a certain amount of equanimity the high interest rates that are killing the very small businesses that they were apparently very concerned about in Opposition.

The small companies that we are concerned about here will now be able—I do not deny that they should be able to do so—to pay interest rates of up to 17 per cent. on money lent to them by participators. I remind the House that that money will now go out as interest, whereas if interest rates had been lower that money could have been kept in those companies for investment, for ploughing back, and for improving the potential and the growth of those companies.

The Minister of State has not told us why it is necessary to bring forward this order now and when the order will come into operation. There is no date on it because, obviously, until the House approves the order no date can be included. But what is the point of bringing the order forward now when we are going to have the Budget in less than two months' time? Why on earth is it necessary, within less than two months of the Budget, to rush through this measure to increase the interest rate from 12 per cent. to 17 per cent.? It could well have waited until the Budget.

I hope that if the Minister of State catches your eye again, Mr. Deputy Speaker, he will tell us what is the purpose of doing this at this time. The question is pertinent, because until the House knows why it is necessary to raise this rate it is very difficult to know whether or not to approve the measure.

We are told by Government Ministers, and we constantly read in the financial press, that interest rates are coming down; the recession is upon us, the Government have got full control of borrowing and are going to cut public expenditure in all directions, and the natural consequence is that interest rates will come down.

If that is so, what is the point of sanctioning a 17 per cent. MLR when the object of the work that the Chief Secretary, the Financial Secretary and the Minister of State will be doing in the next few weeks, on public expenditure—getting a firm control of it and producing their five-year plans and monetary targets—is to reduce interest rates?

I ask the Minister of State to tell the House why it is being asked to approve 17 per cent. and enshrined it in an order on enactment. The background to interest rates is, of course, inflation and borrowing and monetary targets, so I must ask the Minister of State to be a little more forthcoming with the House and tell us, for instance, what the Government's assessments are of the rate of inflation, because this is crucial to intrest rates. We were told that towards the end of this year the rate of inflation might come down to 14 per cent.—I think that is the Treasury forecast. Is that still the Government's estimate? Was that the estimate when this order was discussed in the Treasury? Some people believe that it will be much higher than 14 per cent. by the end of this year. Indeed, it is going to rise to 20 per cent. or more by the middle of the year. If the Government get it down to 14 per cent. by the end of this year, I think that they will be very lucky. I would have thought—the fact that we are being asked to approve a 17 per cent. equivalent to MLR is an indication that the Government agree with me—that the Government will be very lucky if they get inflation down to much less than 20 per cent. by the end of the year.

Again, I think that we should be told something about the public sector borrowing requirement. What is the Government's assessment of the borrowing requirement for next year. If it is going to be lower, why on earth is this order necessary? I remind the House that the 12 per cent. remained effective for about four years. Is the Minister of State now intending that this rate of 17 per cent. should remain effective for four years?

I think that we should be told what the assessments are. Perhaps the Government have no idea what the PSBR is going to be next year—that would not surprise me—but the Financial Secretary has been making very learned speeches in the City explaining these matters, so the Government must have some idea. Will the Minister of State tell us what the PSBR will be? It will be £9 billion this year, so perhaps it will be £9½ billion next year. Who knows? I do not suppose that the Government know exactly.

On a point of order, Mr. Deputy Speaker. Would it be in order for my hon. and learned Friend the Minister of State to give the House the information that the right hon. Gentleman requests, even if he were minded to do so?

That is not exactly a point of order for the Chair. The reply that the Minister of State gives is a matter for him.

I am surprised by the hon. Member for Knutsford (Mr. Bruce-Gardyne). PSBR is not a State secret. Indeed, the hon. Gentleman is one of a group who want four-year targets published for the PSBR. The Minister must have come to an assessment. If not, why bring forward the order? Why put 17 per cent. in the order if no assessment has been made about inflation, interest rates, the PSBR and monetary targets? The Minister owes it to the House to give an indication of the working behind that figure of 17 per cent. Many people want to know. If the Government believe that we are stuck with 17 per cent. MLR for two, three or four years, it is important for the House and people outside to appreciate what is happening.

I hope that there will be some indication. Will the PSBR remain the same? Will it be £9 billion? Will it be £9·5 billion? I do not ask for exact figures. Will it be higher? There is a school of thought that during a recession—this Government have certainly caused a recession—it should be increased. Perhaps it will be £11 billion next year. Who knows? The other component for determining the figure of 17 per cent., apart from the inflation rate and the PSBR, is the monetary targets themselves. I do not ask the hon. and learned Gentleman to provide those.

If we are talking about a PSBR next year of £9 billion, monetary targets of between 7 per cent. and 12 per cent. and an inflation rate of close on 20 per cent. by the end of next year, it makes sense for the Minister to bring forward the order. If we work back from 17 per cent. and assume that the hon. and learned Gentleman will not produce another order in six months' time and that 17 per cent. will be the going interest rate for some time to come, we have a PSBR of between £9 billion and £9·5 billion next year, an inflation rate of nearly 20 per cent. by the end of next year, and a monetary target of between 7 per cent. and 11 per cent., or possibly less. It may well be that that is the Government's assessment and that is why the hon. and learned Gentleman is enshrining in the order an interest rate of 17 per cent.

Will the hon. and learned Gentleman bring another order forward after the Budget, when cuts in public expenditure have been made to reduce the 17 per cent. rate, or is he envisaging that we are stuck with 17 per cent. MLR for some time?

11.17 pm

With his customary adroitness and eloquence, the right hon. Member for Llanelli (Mr. Davies) has sought to enlarge a debate on what is essentially a rather modest order into an examination of an area of Government economic policy. Of course, I am happy to debate with him or with any other hon. Member the validity, advantages and solidity of the Government's economic policy. I do not know whether I should be in order to do so, but I am always happy to respond to the right hon. Gentleman. I know his deep experience, skill, acumen and application to these measures.

The right hon. Gentleman asks for the reason for the order. It is because on all past precedents established by Administrations that he, no doubt, supported—I do not recall whether he was in the House in 1969, but he certainly was in 1974—they felt it right, as we do, to keep the limits in section 285 in line with the bank rate or the minimum lending rate. I do not recall that on either of those occasions it was felt necessary to justify the Government's economic policies. Nevertheless, I feel robustly confident about the Government's economic policies.

The right hon. Gentleman asked me about the prospects for interest rates. I emphasise at once that to establish the reason for this order it is unnecessary for me to convince the House that interest rates will remain at present levels for any length of time. It is a question of doing an elementary measure of justice to those involved in close companies.

The right hon. Gentleman asked where we stand in relation to the small business sector. We stand where we have always stood—unlike the Labour Party. The Labour Party wishes to grind small businesses into the dust. It has no place for small businesses in its mythology. It likes large businesses, whose arms it can twist. Eventually, it can nationalise them. We believe in small companies. The example that we have selected tonight is that of close companies. Perhaps it is a narrow, more specialised corporate instrument, but we believe that to treat those businesses and their directors and shareholders fairly it is necessary to adjust the rate.

That is our philosophy, and I state it with pride. I hope that I have stated it with sufficient clarity to convince the House. Perhaps the right hon. Gentleman is not convinced.

The right hon. Gentleman also asked about the prospects for interest rates. Since the increase in minimum lending rate, three-month rates have averaged about 17 per cent. However, the yield in money market rates has been on a downward slope beyond those three months. That indicates a market expectation of a cooling in short-term rates. Perhaps I do not command the enthusiasm of the right hon. Gentleman. Presumably, he would like to see the minimum lending rate creep up yet further. He is a prophet of doom.

Let us look at what has happened. My right hon. and hon. Friends have stressed that there should be a prospect of lower interest rates. Government policies reduce both the rate of inflation and monetary growth. However, the timing of any fall in that rate must depend on several factors. Of course, we need to be sure that monetary growth is under control.

The right hon. Gentleman should consider with a blush the vagaries of the monetary policy that was pursued by the previous Labour Administration. He was a distinguished member of that Government and presided over that policy. Of course, we warmly commended the actions that he took under pressure from the International Monetary Fund. We were less enthusiastic about his actions in the run-up to the general election. He has pure fiscal and monetary principles. I hope that one day he will stand up boldly and proclaim that he is a monetarist. There are gradations of monetarism. Basically and philosophically, he is not so remote from this Administration in his approach to monetary policy.

We have all read the synopses of Lord Underhill's report in the press. We know the pressures under which the right hon. Gentleman worked prior to the general election. Mercifully, the Government are not under such pressures. Therefore, we shall not relax monetary pressures until we are convinced that inflation has been squeezed out of the economy.

I am a little diffident about enlarging the ambit of the debate, Mr. Deputy Speaker. However, you have been kind enough to treat my intervention with some indulgence. I hope that I can discuss this important question as we shall come back to it again whenever we debate general economic affairs. I also hope that we shall have an opportunity, as the right hon. Gentleman said, to debate the White Paper on expenditure. At about the same time, we shall have an opportunity to debate the Budget. We can then examine the broad and important questions of economic policy.

Perhaps the Minister will be kind enough to address his mind to one question. Why bring forward the order within six weeks of the Budget? Surely, if the Budget and the public expenditure exercise—the cuts of £2 billion that the Prime Minister seeks—have been so successful, he will be able to bring forward an order with an interest rate of 15 per cent. or 14 per cent. If that exercise has been successful, interest rates should fall. Perhaps the Government are not very confident about a fall in interest rates.

The right hon. Gentleman overlooks the fact that it is over two months since the minimum lending rate was put up. He will recall that there have been other consequential amendments. For example, we put up the rates of interest on unpaid tax in early January. I do not recall the right hon. Gentleman and his hon. Friends making a great palaver about that exercise. He reads too much into what is basically a simple and elementary measure of justice to the small company sector.

The right hon. Gentleman may say that he is concerned about the small company sector. If he did, I should admire his candour. Indeed, if he does not rise on this point I shall think the less of him. We know where his heart lies—with the big battalions that he and his hon. Friends below the Gangway feel that they can manipulate when they are in power. They feel that they can twist their arms more readily and that they are more susceptible to pressures from the trade union movement. They feel that at the end of the day they may even be able to nationalise them. That is not our approach.

Let us not get the problem out of perspective. It is a very small—one might almost be disposed to say technical—measure, but it is not entirely technical. It accords a measure of justice to the small company sector.

We recognise that Administrations that the right hon. Gentleman supported have been very ready to adjust without overmuch explanation. We have accepted the adjustments. I do not understand why the right hon. Gentleman has endeavoured to make a mountain out of this relatively small measure. It is a measure of justice. It allows people to take out by way of interest from close companies without fiscal disadvantages.

The right hon. Gentleman and his hon. Friends below the Gangway wish to cram on to the small company sector every kind of fiscal disadvantage. That is one of the great divides between the two sides of the House. We do not share that philosophy. There has been a change since 3 May. One of the small symptoms of that change is this order.

We need not spend over-long on the Government's fiscal and monetary policies. They are well known. I almost feel disposed to apologise to the House for having to elaborate on our monetary policies. We take a firm and robust view.

It is not for me to speculate—indeed, how can I?—as to when it will be possible to bring the minimum lending rate down. The right hon. Gentleman and the City can speculate, but let us wait until circumstances make that propitious.

The right hon. Gentleman is correct to point out that we are only two months away from the Budget. I do not feel that this small measure need wait two months. The circumstances are propitious. They justify it. On that basis, I hope that the House and the right hon. Gentleman will feel that it is entirely appropriate that we should introduce it to the House now and will allow it to pass without any demur or Division.

Question put and agreed to.

Resolved,

That the draft Income Tax (Excess Interest As Distributions) Order 1980, which was laid before this House on 14 January, be approved.