Memo for the FT - double taxation of interest is a seriously bad idea

The FT has tried to think about how the corporate taxation system should be changed:

First, the UK should make “full expensing” permanent.

Second, a wider range of capital investments should qualify for full expensing.

One option would be to gradually curb the amount of interest that can be deducted, which would help cushion the short-term outlay of extending allowances too.

The first and second are simply reductions in the extant distortions of the tax system. You get to expense all of your, umm, expenses, but only over time - depreciation rates, and so on. Full expensing just brings that ability to claim something as an expense forward in time to when you’ve actually spent the money. The only reason we have the system we do is because Chancellors like to get the money to spend now rather than wait for actual profits to turn up. Reversing this seems like a perfectly sensible idea.

Interest though, this seems to be when the thinking stopped. Because interest is currently taxed when it gets to the recipient of it. The interest is paid out on the bond or loan or whatever and that’s then income to said recipient and it’s taxed at whatever income tax rates apply to the recipient. OK, that’s fine.

But to insist that interest should not be deductible at the corporate level is the imposition of a tax upon the interest being paid out. So now we’ve double taxed interest.

Profits paid out as dividends might seem to be double taxed but they’re, in fact, not. The corporation pays corporation tax, the dividend is paid with corporation tax already paid. The recipients then pay dividend tax. But the combination of both corporation tax and the dividend tax amounts to (something like at least) the marginal income tax rate of the recipient. This is quite deliberate. It’s convenient to collect taxes on dividends at the level of the company. But we also want to tax the flow of money only the once.

If interest were not to be a deductible business expense then we’d have to bring in some such system - interest payments that are franked as already tax paid in some manner, given their non-deductibility. Or, we’d end up taxing the interest flow twice, once at the level of the corporation and then again at the level of the recipient.

We could, of course, simply make interest received tax free and also make it non-deductible to the payor. But we tend to think that would not be politically viable. Or stick with the current system of interest being a deductible business expense and a taxable income to the recipient.

That middle road of two types of interest, that which has been taxed at the corporate level, that which has not, along with different tax rates to the recipient well, yes, it could be done. But is anyone’s analysis of the British tax system really that it should be made more complex?