As the result of much labour, first on the part of a departmental committee and then of a joint select committee of the House of Lords and the House of Commons, the Income Tax Act, 1918, was passed on Aug. 8 1918, with effect as from April 6 1919. It did not alter the law. It was merely a consolidating measure. The fact that the whole of 13 Acts and parts of 39 others were repealed by the 1918 Act is sufficient proof that the time was ripe for consolidation.
The long-expected and long-promised inquiry into the tax came within a few months of the cesssation of hostilities. A Royal Commission of 23 members, under the chairmanship of Lord Colwyn, was appointed by Royal Warrant dated April 4 1919. The terms of reference were widely drawn:—“To inquire into the income tax (including super-tax) of the United Kingdom in all its aspects, including the scope, rates and incidence of the tax; allowances and reliefs; administration, assessment, appeal and collection; and prevention of evasion; and to report what alterations of law and practice are necessary or desirable and what effect they would have on rates of tax, if it were necessary to maintain the total yield.” The Royal Commission held 50 sessions, examined 187 witnesses (including 21 official witnesses), and issued a long and comprehensive report (Cmd. 615) on March 11 1920. They also published in two volumes a verbatim report of the minutes of evidence, running to 1,383 pages, and a further volume containing 71 appendices to the minutes of evidence, and an index to the whole. These three volumes contain an enormous mass of information on the subject and are indispensable to the serious student. Among the appendices are a short history of the tax, an exposition of the existing income tax system, historical memoranda on various aspects of the tax, notes on the position in the Dominions and foreign countries, and much interesting statistical information.
The report, which was signed by all the commissioners—the reservations being few and comparatively unimportant—ranged over the whole field of the tax. There was no minority report.
The recommendations of the Royal Commission were very numerous, detailed and far-reaching; only the more important need be summarized here.
In Part I. of the report, dealing with “the scope of the tax,” they recommended that certain classes of non-recurring or “casual” profits, which are now outside the charging words of Schedule D, should be made assessable (paragraph 91); and that British subjects residing abroad should no longer be deprived of the allowances and reliefs granted to residents (paragraph 65). They also proposed a modification of the relief in respect of “double income tax.” On this question of “double taxation within the Empire” a sub-committee of the Royal Commission had conferred with representatives of the Dominions and of India who had come to this country for the purpose, and the report of that sub-committee was accepted by the whole commission. The principle underlying their recommendation was that where income tax is charged on the same income both in the United Kingdom and in a Dominion the total relief to be given should be equivalent to the tax at the lower of the two rates of tax imposed. The recommendation was in the following terms:—
“Firstly, that in respect of income taxed both in the United Kingdom and in a Dominion, in substitution for the existing partial reliefs there should be deducted from the appropriate rate of the United Kingdom income tax (including super-tax) the whole of the rate of the Dominion income tax charged in respect of the same income, subject to the limitation that in no case should the maximum rate of relief given by the United Kingdom exceed one-half of the rate of the United Kingdom income tax (including super-tax) to which the individual taxpayer might be liable; and
“Secondly, that any further relief necessary in order to confer on the taxpayer relief amounting in all to the lower of the two taxes (United Kingdom and Dominion), should be given by the Dominion concerned.” (Paragraph 70.)
In Parts II. and III., which dealt with “Rates and Incidence of the Tax,” and “Allowances and Reliefs,” an entirely new system of differentiation and graduation was proposed. Differentiation in favour of earned income, instead of being effected by a special series of rates of tax, was to be made by deducting one-tenth of the earned income (paragraph 111), in order to arrive at the “assessable income”—a new term—subject to a maximum deduction of £200. The old system of graduation by means of a series of abatements was to be superseded by a new plan. From the “assessable income” various personal and other allowances were to be made—for the taxpayer himself, his wife, children and dependants—and the balance was to be called the “taxable income.” The first £225 of this “taxable income” was to be charged at half the standard rate, and the remainder at the full rate (paragraph 139). Further graduation in the higher ranges of income was to be by way of super-tax on the old lines. The new “personal allowance” was to be £135 for the unmarried taxpayer and £225 for the married couple (equal to £150 and £250 respectively in terms of “earned” income). This, in effect, was a raising of the old “exemption limit” and a considerable increase in the “wife allowance,” but the new “personal allowances” were to be given to all taxpayers, without regard to the amount of their total income. The allowances in respect of children and other dependants were also to be allowed irrespective of the size of the taxpayer's income—a notable change (paragraph 270). The incomes of husband and wife were still to be aggregated for income tax purposes (paragraph 260); the spouses were to be allowed (as before) to make separate returns and to pay tax separately if they wished, but this was not to alter the total amount to be paid, which was still to be fixed by reference to the amount of the combined incomes.
The effect of this new system of graduation was to produce a smooth and gradual rise in the effective rate of tax as the income increased. The old line of graduation proceeded by a series of steps, the rise in some parts of the scale being much steeper than in others; the new plan (as shown by the graphs appended to the report) produced a line which rose smoothly and evenly instead of by a succession of jerks.
The commissioners expressed their strong conviction that the principle of “taxation at the source,” a principle which underlies the whole scheme of the income tax in this country, must on no account be abandoned (paragraph 154). They recommended an allowance, subject to a good many qualifications, for certain wasting assets (paragraph 200).
When they came to deal with the administrative machinery of the tax, in Part IV. of the report, the Royal Commission had much to say that was of interest. The machinery provisions in the Act of 1842, when Peel reimposed the tax, were taken from the Act of 1806, which in its turn followed earlier models, and, as the commission said, looked back for its origin to the old Subsidy Acts (paragraph 331).
However well adapted to the social and commercial conditions of 1806 those provisions may have been, it was inevitable that they should be found wanting when examined in 1920. The Royal Commission found that the smooth working by the machine was “rendered possible only by considerable deviations from the scheme of administration originally conceived by the founders of the tax” (paragraph 331), and that “an attempt by the General Commissioners to carry out the Income Tax Acts literally would result in a breakdown of the machinery” (paragraph 342). They found that the position in the scheme originally allotted to the Crown's representative (the inspector of taxes) had gradually grown in importance with the development of the tax, and they reported that “without this gradual devolution to the inspector the machinery of the tax would have been found to be hopelessly inadequate” (paragraph 331). Most of their recommendations on this aspect of their subject were, as they themselves stated, “directed towards recognizing and giving legal sanction to those practical developments in the working of the tax which have so largely contributed to its success.” They include (a) the abolition of the office of assessor (paragraph 386), (b) the transfer of certain clerical work from the clerk to the local commissioners to the inspector (paragraph 369), (c) the granting to the inspector of the power to make assessments in certain cases. The fundamental feature of the existing system—the right of the taxpayer to appeal against any assessment to the general commissioners, a local and unpaid body—was approved by the Royal Commission, but they made various suggestions as to the personnel and the tenure of office both of those commissioners and of the additional commissioners (another local unpaid body by whom assessments under Schedule D are made).
Part V. dealt with “assessment, appeal and collection” and covered a great variety of subjects. Among other things the commission proposed a rearrangement of the contents of the five categories or “schedules” into which incomes are divided for income tax purposes. Certain properties (such as railways, mines, gasworks, docks, etc.) were to be transferred from Schedule A to Schedule D which is the schedule under which profits of trade are charged; farmers' profits were to be transferred from Schedule B to Schedule D; and all incomes from employments were to be assessed under Schedule E which now includes certain classes of employments only. To the new Schedule D as so reconstituted a new basis of assessment was to be applied. The existing basis for Schedule D assessments is, generally speaking, the average of the profits of the three preceding years; but some classes of income are assessed under Schedule D on other bases. The incomes proposed to be transferred to Schedule D are also assessed on a variety of bases. The Royal Commission recommended that all this assortment of bases should be swept away, and that all the incomes to be assessed under the newly constituted Schedule D should be charged on the one uniform basis of the income of the preceding year.
Recommendations were also made with regard to the income tax liability of cooperative societies, but to these proposals there were several reservations (printed at the end of the report) on the part of some of the commissioners.
Part VI. was confined to the question of evasion of the tax and to the suggestion of possible preventive measures. The commission
