What does the minister mean by "net profits"? Most of the companies are in the habit of allowing a reserve for depreciation of plant-from five per cent to ten per cent, according to the kind of business; does the minister intend that they shall still be allowed that in their statements? Then, some companies have assumed as assets organization or goodwill; does the minister purpose making any allowance for organization in the capital stock in arriving at the basis of taxation?
SiT THOMAS WHITE: The term "net profits" has, I believe, a well-understood significance under legal decisions. Gross profits are, of course, the entire profits derived by the company, and, in order to get at the net profits, there should be deducted from the gross profits all costs and charges of administration, including, of course, interest upon debentures or money borrowed. Thus, in companies such as, I think, the hon. gentleman has in view, it will be proper to deduct an amount for depreciation of plant. We discussed that matter on Friday, in the absence of my hon. friend, and on that occasion I stated that the percentage which should be allowed for depreciation was a question of fact. In one class of business it might be greater than in another, and in the case of an individual business it might be greater than in another business of the same character. In each instance it is a question of fact. But, as to the principle of the charge for depreciation, there is no doubt that a proper charge should be deducted from gross profits in order to reach net profits. The hon. gentleman has asked with regard to
organization and good will. These present difficulties, I should say that, unless in exceptional cases, such as I have not in mind at the present time, organization charges should not be allowed as part of capital. There may be cases in which it would be proper to allow such chargee as part of capital; but, as I say, I have not any such case in mind at the present time. So far as goodwill is concerned, the English Act allows the commissioners discretion in that regard. There might be cases in which a certain amount would be allowed for goodwill, but, generally speaking, the act contemplates tangible capital, that is to say, assets, real and personal, movable and immovable, less liabilities.
I understood the minister to say some days ago that the matter of what would be allowable as capital in respect of what we call over-capitalized companies would be referred to the Minister of Finance. There are instances where companies not over-capitalized have credited themselves with a certain amount for organization, which, as the minister knows, is a very legitimate and necessary expense in connection with starting a business. In cases where the organization expense was absolutely legitimate, does the minister purpose allowing that expense as capital?
.Sir THOMAS WHITE: I should hesitate to make a general statement about that: I should not like to make the assertion thht it would be allowed in every case, or that it would be disallowed. There might be cases in which a certain amount for organization would be properly allowable as capital, but my judgment would be that, in most cases, it should not be allowed as capital. We should deal with more tangible assets.
It often occurs that each year such companies as I mention write off out of their profits a certain amount against organization. If that is legitimate, and I think it is, it would seem reasonable that the minister should allow that as capital for the purposes of this Act.
I do not think that I can advance the matter any further than I have. The desire is, so far as possible, to put the over-capitalized company, so called, upon the basis of companies that are capitalized on the basis of payment in cash for their shares, and on the basis of individuals, firms and partnerships that have a certain amount of capital, as usu-
ally understood, in their business. In the case of a private firm, we have a certain amount of cash, we have goods, we have real estate, used in the connection with the business,' and we have liabilities. Deduct the liabilities from the total assets and you have the capital. In the case of an ordinary company whose shares have been paid in full in cash, if that capital so obtained by the company had not been impaired, then the capital would be the amount paid in on its shares. My hon. friend mentions the case of a company that has paid out a good deal for organization. It would seem to me that that payment is expenditure; that is to say, the capital of the company in one sense at least, has been depleted by payment out for the expense of organization. My hon. friend has in mind that the organization itself representing an amount paid out of capital, is of value; he asks whether that should be allowed as capital for the purposes of this Act. 'My view would be that, generally speaking, it would not. It is conceivable that there might be cases in which an allowance should be made, but if I were to make a general statement, it would be against such an allowance.
Frequently preferred stock is sold at par. If it is handled by brokers, a commission is paid for the handling, and that commission is charged to organization. As a rule the brokers are given common stock for that commission. Does the minister not think it is fair to allow that as capital, so far as it has been legitimately paid to brokers or otherwise, for selling the stock?
I think it would not be proper to consider what was paid to brokers for selling the stock We desire to place the over-capitalized company, so far as we can, on the basis of the company that is not over-capitalized and on the basis of the individual and partnership firm that is engaged in business. Therefore it gets down to this question: what is the value of the assets, real and personal, movable and immovable, of the company, and what are its liabilities? If we could ascertain that accurately, and subtract the liabilities from the assets, we would have the value of the stock, of the rest and reserve and accumulated profits of a company, whether overcapitalized or properly capitalized. I do not think that it would advance the consideration of the matter very much to inquire whether common stock given for an intangible consideration, such as goodwill
or organization, should be allowed at its par value. I would eliminate these intangible features. That is to say, I want to eliminate capitalized goodwill, except in exceptional cases. I want to eliminate, organization expenses, in order that all overcapitalized companies, properly capitalized companies, and individual firms may be on the same basis so far as this taxation is concerned.
declared-and not until it is declared-is a liability of a company, I believe, as between it and its shareholders. But for the purposes of this Act we could not regard as liability accumulated dividends on preference stock; I do not think it just that we should. A good deal is to be said for the fact that the dividends have not been paid upon the preference stock, but, on the .other hand, if the company becomes liable under this Act, it only means that since the outbreak of the war it has been able to make profits that it did not make before. Therefore we think it proper that they should pay a certain amount of the profits so derived to the State.
company that had made profits out of the war; I meant the ordinary company. During 1913-14, many companies did not pay their preferred dividends. These preferred dividends were accumulated, and, in my judgment, are an absolute indebtedness of the company-that is, if they were earned. Owing to lack of banking facilities, these dividends were not paid. In other words, the banks got very stringent with reference to the paying of dividends. The dividends were carried on the books of the company as a liability, and they were a liability of the corporation proper.
I think my hon. friend will see where that would lead us. Assuming that a company of that kind has paid no dividends on its preferred stock for three or four years, but, since the outbreak of the war, has earned 25 per cent upon its capital, which includes its preferred capital as well as its common capital, this Act would apply to the earnings so made for the accounting periods ending since the outbreak of war. I think it is proper that it should; otherwise the company would escape from paying, where others were paying, a portion of the excess
profits which it had made as the result, directly or indirectly, of the outbreak of the war.
No matter what may be the point of view of the Treasury Department, I fail to see how the minister can logically argue that it is not a liability to the shareholder which must be redeemed; and, so long as it is outstanding, how can you say that there were profits which you should tax?
There is a distinction, but would it be fair for the department to rest upon a technicality of that kind, even if the dividends were declared but not paid? I would assume it was a liability. That liability should be discharged before the profits are taxable. I do not see any reason in equity why the same reasoning should not prevail whether or not there was a declaration of dividends. Of course, the minister can overcome that by some specific legislation on the point; but I do not think that, under his resolutions as they stand at present, he could hold that a company could not pay past dividends, whether declared or not declared; I mean in connection with preferred cumulative shares.
The Act applies to any profits made in the accounting period. There is really no difference in principle between dealing with preferred shares and common shares. Preferred shares may be cumulative; that is to say, an arrangement may have been made by legislative authority or by the
4 p.m. shareholders among themselves whereby no dividends are to be paid upon the common stock until dividends at a certain rate have been paid upon the preferred stock. But there is no essential difference between the two stocks as to their character; so far as the public is concerned, they are both capital. It would be just as logical to argue that because a company had not paid dividends for some years upon its common stock, that should be taken into consideration, as it is to argue tnat all back dividends upon preferred stock should be paid before this tax becomes operative. My hon. friend, as a lawyer, knows that there is a difference between declared dividends and dividends which are cumulative but not declared. There is a real difference there, and we are dealing with the case of
cumulative dividends not declared. As to what the legal effect would be of a declaration with respect to cumulative profits, I am not prepared to sav for the moment; but the intention of this Act is to assess any profits arising in the accounting period.
The minister's illustration is so far away from the companies I have in mind that it has little bearing. He talks about the companies earning 25 per cent on both their common and preferred stock on account of the war. That is not the kind of company I was asking about. I am asking about companies that earn nothing extra on account of the war; the war has nothing to do with their earnings. I refer to companies which, say, the year before the war broke out, that is, in 1913-assuming that their financial year ended on the 1st of April-earned their dividends; but were prevented from declaring and paying them owing to the objections of the banks. I am speaking of companies that did not earn any 25 or 20 per cent, but earned their dividend, whatever it may be, 6 per cent or 7 per cent, on the cumulative shares, but did not pay it in 1914.
The war broke out only in August, 1914, and the next fiscal year ends on the 1st of April, 1915. The minister can see that, long before the war affected them at all, they had made half their earnings for the year; that is, during the period between April and August. They have earned their dividend, we will say 6 per cent or 7 per cent, but they have not paid it on account of the objection of their bank. The directors, perhaps, have not declared it, because there is not much use declaring a dividend unless you are in a position to pay it; your .shareholders expect you to pay it if you declare it. That is what I mean, and I do not think it is right for the minister to impose his tax in such a case. There may be exceptional cases such as ,he quotes, and in these cases I think the companies should pay, where there are earnings of 20 or 25 per cent, or even 10 or 12 per cent. But where they have just earned their dividend out of their own legitimate business, and they, owe it to the shareholders, I think the minister ought to except them; and I believe that when he thinks it over he will come to the same conclusion, because all we want is what is fair in this or in any other business. -
In the case of an ordinary industrial company that made last
year 5 or 6 per cent, but did not declare any dividends because of the unsettled condition of trade and, perhaps, because of lack of banking accommodation, and allowed earnings to go to profit and lose, but this year earned another 6 or 7 per cent and so was able to declare a dividend of 10 or 12 per cent for the two years, but did not earn 14 per cent in the two years, or more than 7 per cent in either year, would the company be taxable under this legislation?
As I understand the hon. member, he saye, supposing for the first year the company earned 7 per cent but did not pay it to its shareholders," and the next year earned 7 per cent, and at the end of the next year paid the 7 per cent which it made the first year and the 7 per cent which it made the next year, to its shareholders, namely 14 per cent, would the tax be upon the 14 per cent? The answer is that! during the accounting period in question, only 7 per cent was earned, and therefore the tax would not apply. '
In answer to my hon. friend from North Oxford (Mr. Nesbitt), he will realize that, if they did not pay the dividends at the end of the accounting period terminating before the war, but had earned them, the dividends would be in rest account, or in reserve account, or in profit and loss account. They wou'ld then be taken as forming part of the capital upon which the earnings in the succeeding accounting period were estimated. Those profits or earnings not distributed would not be added to the profits of the next accounting period, and the company then taxed upon them both together. But I cannot see on what principle we could allow dividends not declared but cumulative, or dividends earned but not paid, upon common or preferred stock, to be considered as -a liability of the company. I think it would be in violation of the principles of law.
the same application to bondholders? Industrial concerns, being unable to finance before the war, have evolved a scheme by which their bondholders have agreed to allow interest on the bonds held by them to remain in the treasury unpaid for two or three years. They would be in identically the same position as preferred shareholders?