Section 27 Finance Act 1967 - Financial Business

Section 27 of the Finance Act 1967 in the United Kingdom introduced significant changes to the taxation of close companies, impacting how their profits were treated for income tax purposes. A close company, generally defined as a company controlled by five or fewer participators (or by participators who are directors), faced potential assessments on undistributed profits. The primary aim of Section 27 was to prevent tax avoidance by shareholders of these companies retaining profits within the company to avoid higher rates of income tax applicable to personal income.

Prior to the Finance Act 1967, shareholders of close companies could effectively avoid paying income tax on profits by accumulating them within the company. Instead of distributing dividends that would be subject to personal income tax, profits could be reinvested or held as retained earnings. Section 27 sought to address this perceived loophole by giving the Inland Revenue (now HMRC) the power to assess shareholders as if they had received a distribution, even if no actual distribution had occurred. This was known as a “surtax direction” (surtax being a higher rate of income tax levied on high incomes at the time).

The key mechanism of Section 27 involved the Revenue forming an opinion that the company had not distributed a reasonable amount of its actual income. This assessment was subjective and required careful consideration of the company’s circumstances. Factors taken into account included the company’s current and future business needs, the level of investment, and any debt obligations. If the Revenue determined that the company had retained an excessive amount of profit, they could issue a direction deeming a portion of the undistributed profits to be distributed as income to the shareholders. This “deemed distribution” would then be subject to income tax at the shareholder’s marginal rate.

Several safeguards were built into the legislation to protect genuine commercial operations. The burden of proof was on the Revenue to demonstrate that an insufficient distribution had been made. Companies had the right to appeal against a direction, and tribunals could review the Revenue’s assessment based on the specific facts of the case. Furthermore, certain types of income were excluded from the scope of Section 27, such as income applied in repayment of certain loans or used for specific capital expenditures deemed beneficial to the business.

The impact of Section 27 was considerable, particularly for smaller, family-owned businesses. It created uncertainty and required careful tax planning to ensure compliance. Companies had to carefully document their business needs and justify their dividend policy to avoid potential tax assessments. While the specific provisions of Section 27 have been repealed and replaced with different rules concerning the taxation of close companies and dividend income, its legacy remains. It served as a significant intervention in corporate tax law, highlighting the ongoing tension between facilitating genuine business investment and preventing tax avoidance through the accumulation of profits in closely held companies. The principles established in Section 27 influenced subsequent tax legislation aimed at ensuring fair taxation of corporate profits distributed to shareholders.