How E.P.T. Can Affect Financial Equilibrium
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Demonstrating the Manner in which a Trading Organization will Have to Lower the Nominal Value of Its Capital Assets to Fulfil Its E.P.T. Obligations
IT is quite obvious that the strain whiCh has been brought about by the presence of war conditions has necessitated a considerable amount of financial overhaul. The lead in this matter has been given by the Government, which is taking every possible step to avoid inflation. Similar preventive zneasures should be taken by every manufacturing and trading organization, in order -to avoid any likelihood of disaster through a policy of lack of foresight.
The Government imposed the Excess Profits Tax for several reasons, the principal of which are :—(a) To create a source of additional revenue ; (b) to make it impossible to accumulate vast wealth by taking advantage of war conditions ; (c) to assist in the measures which combat the inflatory tendency.
The announcement of the re-imposition of an Excess Profits Tax was not unexpected, but the extent of the actual taxation was generally regarded. as staggering. That the outcry was not ill-founded is now supported by the concessions which have been made by the reduction from the initial basis of 100 per cent, to the future basis of a net 80 per cent.
Striking at the Root The removal,, even for the purposes of carrying on the war, of almost the whole of the trading profit made annually, served rather to defeat, in part, its own ends. Taxation at the rate of 100 per cent. cancels immediately any desire to operate economically.
The prosecution of war plans and the exerution of munition schemes have drawn nearly the whole of the industries of this country into the Government machine. The position to-day is that all concerns still in operation are virtually Government contractors of either a direct or indirect character. A large percentage of this Government work is executed on a 'cost plus" basis and it remains only for the contractor to be able to substantiate his costs so that he collects them together with the
• agreed percentage of profit.
In this manner the normal demands for exact costing are somewhat eliminated, as is the natural wish to operate on an economic basis for the purpose of profit making. Taxation at the rate of 100 per cent, over and above certain standards has tended to introduce methods of gaining moneys over and above the standard allowed, the excess balances, naturally enough, being kept for domestic use.
The most common schemes now in use are those of inflating expenditure, such as trade expenses, travelling. administrative costs and selling expenses, the immediate 'objective being to create or acquire assets of a definite capital character which will, after the war, be of decided company or personal benefit.
Whilst, in many cases, the execution of large Government work will have had the result of raising trading turnovers to figures hitherto inexperienced and, in consequence, substantial increases• in these sources of expense would appear justified, it is doubted whether the totals under these headings would stand the closest of scrutinies. The fulfilment of Government work and the realization of large turnovers tend to give the appearance of large profits.
Net-profit Level Down Experience,: however, has demonstrated that the substantial rise in costs and the additional burden of cost investigation have reduced the net profit level to one more often than not below the level of pre-war trading. Apart from these expenses, the drain on liquid resources brought about by the turning over of working capital four or five times annually in place of, say, twice a year is an item of expense not to be overlooked„ The Excess Profits Tax, as a piece of war-time legislation, was a very necessary step and one at Which few will complain. The size of the tax is the basis of present complaints. It is generally appreciated that a 75 „ per cent, straight tax with the balance under proper control would be a means for rendering greater financial service to the country than the system now in force. The concession to industry, in the shape of a reduction from 100 per cent, to 80 per cent, is a concession in name only, for the odd 20 per cent. will be• returned after the war.
Whilst the payment of E.P.T. will constitute a hardship, principally after the war has terminated and war contracts have been wound up, it is equally possible for such payments to carry with them most unpleasant domestic financial troubles, unless strict control be imposed and adequate provision be made in cash for current and anticipated taxation liability.
tinless reserves be put by regularly it will be fully possible for an organization to develop its financial policy in such a manner as will put it in the position of having to pay E.P.T. out of losses, with payments being effected only after the drawing on, or the realization of, capital assets.
This situation could arise by (1) permitting certain expenses to occur which are disallowable from the point of view of E.P.T., particularly in the case where salaries are paid to controlling directors ; (2) expenditure of large amounts of capital in the form of plant.
In addition to this, many companies are obliged to reduce a temporary bank overdraft by capital repayments regularly. The example quoted below shows how, in quite a normal case, it will be necessary to pay a substantial sum out of actual assets.
Reliefs Offered There are, of course, certain varying reliefs offered in the application of E.P.T., and these apply, in ,particular, where working capital has been increased during the periods covered by the`tax. These reliefs are, nevertheless, of relatively minor importance.
It has been the writer's intention to demonstrate the possibility. of E.P.T. having* a detractive influence on financial standings, whilst the actual payments benefit the Exchequer. The means for evading financial disequilibrium are simple—more firm and strict control of all aspects of financial policy, thorough investigation of all expenditure before it is incurred, and the conservation of the highest amouqt of liquid reserves as is compatible with commercial security.