EXCESS PROFITS DUTY OR TAX, a tax on the excess of the actual profit of an accounting period over a standard of profit.
Following the outbreak of the World War in 1914 it was appar ent, from the movement of the monthly index numbers of the wholesale prices of commodities, that profits of businesses, espe cially of those concerns whose products would immediately be in increased demand, would move upwards at a rate even greater than that shown by the index number. The results shown by accounts of trading concerns embracing part of the War period more than confirmed this anticipation. So the excess profits duty was born. It was imposed by Part 3 of the Finance (No. 2) Act which passed into law on Dec. 23 of that year.
The excess profits duty was a duty, where a chargeable profit existed, on the profit of businesses carried on in the United King dom or carried on elsewhere by persons ordinarily resident in the United Kingdom. Agriculture, professions and employments were exempt. The duty was imposed upon the profit of a business con cern as an entity, and not by reference to the profit or income of individuals as such. A chargeable amount of profit was the excess of the actual profit of an accounting period over a standard of profit increased by certain free allowances. An accounting period was in general the period for which the accounts of the business were made up. Profit was determined, subject to certain modifica tions, on the principles which determined profits under the Income Tax Acts.
To preserve comparability provision was made for a reduction or increase of the profit of the accounting period, by reference to a statutory percentage upon the additional or reduced amount of capital employed in the accounting period as compared with the capital employed during the period or at the date to which the standard related.
Capital as computed for the purpose of the duty represented the proprietors' trading capital, and borrowed money was, there fore, excluded from the computation of capital. In general, capital of a business consisted of money; assets acquired by purchase at the price paid, subject to any deductions for wear and tear or re placement ; debts due to the business and assets not acquired by purchase taken at their value when they became assets of the busi ness. Accumulated profits employed in the business were treated as capital; any capital (the income of which was not taken into account in computing profits for the purposes of duty) and any borrowed money or debts were to be deducted in computing the capital.
Special provisions affording relief from the full weight of the duty were introduced as from Jan. 1, 1917 in the case of small businesses.
A percentage—equal to the percentage rate of duty in force for the period concerned—of any deficiency of profit of a business below the standard in any accounting period was set off against the amount of duty applicable to an excess of profit over the standard in another period. The rate of duties varied between 40% and 8o% of the excess profits chargeable.
The Act limited the profits to a retainable amount, ascertained in accordance with the statute and rules made thereunder. Any ex cess of net profits of the establishment over such retainable amount was payable to the exchequer as a munitions levy.
Controlled establishments liable to the munitions levy were also liable to the general excess profits duty but their total liability was limited to the higher of the two charges. From Dec. 31, 1916, the rate of excess profits duty became, practically without exception, the heavier charge. The munitions levy was therefore terminated at that date.
Where a taxpayer had been required to pay an amount of duty in excess of his aggregate net excess profits over the whole period for which the duty was in force, provision was made that the ex cess should be remitted or repaid.
Part of the productivity of the duty was due to the continuous rise of the price level. To take care of any heavy losses arising from a heavy fall in prices, after the duty was repealed, complex provisions were contained in the Finance Act 1921, granting three reliefs in connection with trading stocks, two of which were alter native to one another.
The net amount of duty collected and retained in the British Exchequer from the inception to the end of the tax was approxi mately f 1,28o,000,000. 1«7 T-T ('' The strong currents against taxation of business in this indi vidualistic country made excess profits taxes almost unthinkable until recent times. Georgia in 1863, it is true, levied for a short time what was in effect an excess war profits tax (upon profits above 8% of the value of capital stock at rates progressing from 5 to 2 5 %) . In March 1917' a Federal excess profits tax was enacted but labelled a special preparedness fund. In October 191 7, on actual entry into war, a higher rate was applied to all trades, professions, etc. (with an exemption of $6,000 for indi viduals and partnerships, and $3,000 for corporations). No one then considered such a tax as anything but a temporary war-time expedient, based upon the known extra profits enjoyed in war munitioning. The 1917 excess profits tax returned $101,249,281 from individuals, $103,887,984 from partnerships and from corporations; a grand total of $1,843,885,505• After a dual tax (8o% war or 3o to 65% excess profits tax, whichever was greatest) was applied in 1918, the excess profits tax was continued in 1919 and 1921 as a "supernormal" profits tax, meaning in excess of pre-war profits ; a principle also used by the British tax. This introduced a new theory, that an exemp tion based on invested capital was well designed for a permanent tax, preventing those unusually prosperous in pre-war times from escaping. After 1918 only corporations were taxed and the tax was coupled with a capital clause, an exemption of $3,00o plus 8% of invested capital. If income was in excess of this credit, but not in excess of 2o% of invested capital, the rate was 20%; re maining income at 4o%.
The yield in 1918 reached (largest known tax return), but declined by 1921 to when the tax was repealed, among other reasons because of inequalities and com plexities.
In 1933, under the pressure of depression, a new excess profits tax was inaugurated, tied to a capital stock tax; an impost of 5% on net income of corporations in excess of 124% of "ad justed declared value of capital stock." This tie to capital stock is an effort to avoid evils of over-capitalization. An abnormal decrease in income for any year reduces capital stock tax, but increases excess profits tax if normal income is resumed in sub sequent years. An abnormal increase of income increases both capital stock tax and excess profits tax. An error of overvalua tion however appears still to be preferable to one of undervalu ation. There is still difficulty in decision as to what constitutes excess profit, even though the new tax is more liberal. There is a paradox in the fact that the tax was first applied to a period of ab normal prosperity, and then to a period of abnormal depression.
Excess profits taxes may thus be said to have moved through three stages: (I) munitions taxes in war periods; (2) inclusion of all business in war and post-war profit periods; (3) peace time tax on profit above an assumed percentage. Thus a tax re garded as intolerable except in war periods has been imposed in peace times, possibly as permanent taxation, although regarded by many as curbing initiative and raising prices. At first con sidered impracticable of administration because of subterfuges in avoidance, the new tie to capital stock taxation renders it more feasible, because of pressure toward a balancing of profit with capitalization. The tax is however still in an experimental and uncertain stage, as a permanent tax.
The United States tax situation in general is regarded as requir ing shortly a general agreement on taxation among its various political localities, so that the Federal, state and minor localities be assigned their separate and particular fields of revenue. Also that a more scientific readjustment of Federal taxation be made, on a more stable and just sociological theory of taxation for America, equitably and wisely distributing America's mounting tax burden. Search for new, rather than elimination of older taxes is forecast. Thus there is no outlook for repeal of excess profits taxation, although corporation taxation in general may be amended, and undistributed surpluses made the special object of taxation.
As a war-period taxation measure the excess profits tax was conspicuously successful, not only in returns (producing 2 5 % of total receipts in 1917-1919), but also in public acceptance. It had long been recognized that in war periods certain favourably situated corporations profited enormously. The tax was regarded as patriotic justice. The tax did not injure business, because of discretionary administration, normal exemption and relief provisions. Its chief defect was favouritism to over-capitalized concerns; a condition remedied by the new coupling to capital stock taxation, a novelty in taxation. This capital stock tax, it is believed, produces more revenue than the excess profits tax. It is not now, as at first, regarded as against public interest be cause it might be passed on, with increases, to consumers.