the impact of war taxation on eighty canadian corporations

The Impact of War Taxation on Eighty Canadian CorporationsAuthor(s): Lucy MorganSource: The Canadian Journal of Economics and Political Science / Revue canadienned'Economique et de Science politique, Vol. 8, No. 4 (Nov., 1942), pp. 566-583Published by: Wiley on behalf of Canadian Economics AssociationStable URL: http://www.jstor.org/stable/136924 .

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THE IMPACT OF WAR TAXATION ON EIGHTY CANADIAN CORPORATIONS*

IN pre-war days corporations paid a Dominion income tax of 15 per cent on net income, or 17 per cent if they consolidated their returns

with those of subsidiaries. In the case of unincorporated businesses- partnerships and sole proprietorships-income tax was levied on the individual incomes of the persons participating in the business; no tax was levied on the business as a unit. Under present taxation schedules, the corporation income tax stands at 18 per cent; 20 per cent for companies making consolidated returns. Proprietorships pay higher taxes through the steeply increased individual income tax rates. And, finally, the excess profits tax has been superimposed on the previous tax structure.

The excess profits tax applies to all businesses, incorporated and unincorporated. In addition to the taxes assessed under the Income War Tax Act, they have paid up to the present either a flat rate on their total profits (in 1940, 12 per cent for all businesses; in 1941, 22 per cent in the case of corporations, 15 per cent in the case of other businesses) or 75 per cent on profits in excess of pre-war profits, whichever tax was the larger. The provisions listed in the Income War Tax Act for the exemption of educational, charitable, labour, farmers', and other such organizations apply equally to this tax. Otherwise it was assessed in 1940 and 1941 against every business in Canada having a profit, before any payments to partners, proprietors, or shareholders, of more than $5000, with the proviso that any part of the tax which would reduce the profit thus defined to less than $5000 was not to be paid.'

Corporations to which the 75 per cent rate was applicable might sub- tract from their excess profits, before calculating their tax, the amount of income tax already assessed against those excess profits at the 18 per cent corporation rate. Thus the effective rate of excess profits taxation on corporations in 1941 was 614 per cent and the total tax payable on excess profits was 612 per cent plus 18 per cent, or 791 per cent. If,

*This paper was read at the Annual Meeting of the Canadian Political Science Association in May, 1942.

'Under the most recent budget, rates of which became effective from July 1, 1942, thus applying to half of the 1942 income, all businesses, including the small businesses with profits of $5000 or less, pay, under the Excess Profits Tax Act, a flat rate of 12 per cent on total profits. In addition, those with profits of over $5000 pay either an additional tax of 10 per cent on total profits or 100 per cent of excess profits, whichever tax is the greater, 20 per cent of the amount taken at the 100 per cent rate being refundable after the war. The minimum tax on corporations, therefore, including the corporation income tax, is 30 per cent for corporations with income of less than $5000 and 40 per cent for others.

566



Impact of War Taxation on Eighty Canadian Corporations 567

however, they came under the 22 per cent schedule, they might make no such deduction before assessing the excess profits tax, but must pay a flat 40 per cent on total profits. Thus the minimum tax on corporation profits was 40 per cent.

So much for the rates of taxation. We come now to the core of our problem. How, actually, did the rates described impinge upon business profits? In some respects the term "excess profits tax" is a misnomer. Actually the excess profits tax is a war tax on business whether or not there be an excess of profits over the pre-war period. A preliminary picture of typical tax bills payable under 1941 schedules will illustrate this point, and also make clear the impact of the tax at varying levels of increased business. (In order to avoid confusion, I have in every case described profit before taxes as " net income" and profit after taxes as "net profit."

Now let us study the hypothetical case of a corporation which in 1938 had a net income of $100,000. Under the rates then prevailing it paid 15 per cent Dominion corporation income tax or $15,000, leaving it a net profit of $85,000. Let us suppose, in the first case, that in 1941 its net income had not increased, or had increased only slightly. Since it must now pay a tax of 40 per cent, its net profit was sharply decreased in comparison with 1938. Mathematically, its net profit did not equal the $85,000 it made in 1938 until its net income had increased by 41f per cent. Beyond that point, net profit became increasingly greater than 1938 net. Let us assume, in the second case, that the corporation had doubled its net income in 1941-that is, increased it to $200,000. Being subject now to the 18 per cent on total profits plus 75 per cent on excess profits, it paid a total tax of 48 per cent of net income, and its net profit was $102,500. Actually, a company became subject to the 75 per cent rate when it had increased its net income by 55.69 per cent. Let us assume, in the third case, that the corporation had tripled its net income in 1941-that is, increased it to $300,000. Its total tax was now 59 per cent of net income, and its net profit $123,000.

The foregoing analysis is over-simplified in that it takes 1938 as representing the pre-war or standard period, and in that it disregards entirely provincial corporation taxes. It does serve, however, to throw into clear relief the broad effects of war taxes. On the one hand, they sharply curtailed the net profits of companies which had not increased their net incomes as compared with pre-war days, allowing a company to break even only when it had considerably increased its net income. On the other hand, beyond this point they permitted increased net profits, though the greater the increase in net income the greater the percentage of it that must be paid out in taxes.



568 The Canadian Journal of Economics and Political Science

An analysis of the 1939 and 1940 balance sheets and profit and loss accounts of eighty companies may be useful in demonstrating the initial effects of war taxation in actual practice. It must be borne in mind, however, in following the analysis that the full weight of the rates just described had not yet made itself felt in 1940. The rate of excess profits taxation on companies subject to the rate on total profits rather than to the 75 per cent rate on excess profits was 12 per cent in 1940, not 22 per cent as in 1941. The minimum rate of taxation was therefore 30 per cent instead of 40 per cent. The burden on companies where excess profits were moderate or absent was not as great as in the quoted examples based on 1941 rates.

Eighty companies is a small sample of Canadian business, perhaps too small to serve as a basis for dogmatic generalizations. Nevertheless, since it includes both large and small companies and represents widely diverse aspects of Canadian business, it furnishes at least some indication of what is going on in Canadian business at large. The companies were chosen from among those with shares listed on the Toronto Stock Ex- change solely on the basis of their having fiscal years ending on December 31, and so having been subject to a full year of war taxation at the time the comparison was made. This method seems reasonably likely to yield a random sample, unless the fact that the companies have shares listed on the Exchange may be considered to give it a bias in the direction of financial strength.

Of prime importance in assessing the results of war taxation is the question: what effect has this taxation had on the amount of net profits and on the rate of profit? There is abundant evidence of increased business activity as a result of the war. Has this stimulation meant higher profits? Does the evidence bear out the extremist contention that huge profits are being made out of the war? Or does it bear out the equally extremist but opposite contention that business is being choked by the excess profits tax? The answer suggested by this sample is an interesting one: for these eighty companies, the net profits of 1939 and 1940 were identical to within a fraction of one per cent, and the rate of profit (net profits expressed as a percentage of net worth) remained constant at approximately 8? per cent.

Increased business activity resulted in an aggregate increase in net operating earnings of 27 per cent. Net income available for taxes increased by 30 per cent. The tax bill of the group increased by 142 per cent. In 1939 taxes amounted to 21 per cent of net income available for taxes, in 1940 to 40 per cent. The effect of the increased taxation rates was, therefore, on the whole, just to drain off the increased profits due to the war. Wide divergencies from this general picture existed, of




course, over the range of companies; and since the extremes as well as the mean are important in assessing the effect of war taxes, an analysis of these general figures is in order.

Net operating earnings, as the clearest reflection of increased business activity, the relation of which to profits and taxes is of prime importance, have been chosen as the basis for classifying the groups of companies within the sample. No strict correlation can be established between changes in net operating earnings and changes in taxes or profits. Between net operating earnings and net income available for taxes intervene deductions, varying widely between companies, for such items as depreciation and bond interest, and additions of income, often non-taxable, from sources other than operations. One company, for instance, failed in 1940 to receive income from subsidiaries which it had received in 1939, and therefore, although its net operating earnings were well above the point at which profits should have increased, its net profits were down as compared with 1939. Nor does there exist a rigid relationship between net income available for taxes and the amount set aside for taxes. Al- though the minimum tax rate in 1940 was 30 per cent, ten companies devoted less than 30 per cent of their available net income to taxes. COne company, receiving a very large amount of non-taxable income in 1940, which it had not received in 1939, showed an altogether disproportionate decrease in percentage of net income devoted to taxes and percentage increase in net profits. Such factors as accruals of tax-free income account for the comparatively low percentage of taxation paid by the oil companies and for the apparently contradictory situation in the transportation group, where, despite the sharp increase in tax rates, the percentage of net income devoted to taxes actually decreased in 1940 as compared with 1939. In spite of the factors that tend to distort and obscure it, however, the underlying relationship between net operating earnings and profits appears clearly in Table I.

The increase of 27 per cent in aggregate net operating earnings covered wide variations in different types of industries. All groups showed increases, but these varied from less than 10 per cent in the utilities and the consumer industries to well over 100 per cent in the electrical equipment and machinery groups. The oil, iron and steel, non-ferrous metals and minerals, and textiles groups approximated fairly closely to the general figure of 27 per cent. The transportation group, which may almost be considered a war industry, and the miscellaneous group, made up predominantly of war industries, showed nearly 40 per cent increase. The still greater increase of over 70 per cent in the paper group stems from the contrast between the depressed state of the industry in the pre- war years and the sudden acceleration resulting from war demands.




Although increases in net operating earnings were the rule, eleven companies showed decreases. These eleven belonged to no particular groups, but were scattered throughout the sample. The four companies that had showed operating losses in 1939 regained their position in 1940. Of the remaining sixty-five companies, thirty-seven showed increases in operating earnings up to 50 per cent, eleven from 50 to 100 per cent, nine from 100 to 200 per cent, and eight 200 per cent or over. It is worth noting that, with one exception, the eight companies showing increases of 200 per cent or more were comparatively small, that is they were com-

TABLE I CHANGES IN TAXES AND PROFITS OF EIGHTY COMPANIES FROM 1939 TO 1940, BY

INDUSTRIAL GROUPS ARRANGED ACCORDING TO PERCENTAGE INCREASES IN

NET OPERATING EARNINGS

Per cent Per cent Net increase Per cent of net Per cent

worth in net Rate of profit increase income change Industrial group in oper- Per cent in devoted in net

mil- ating taxes to taxes profits lions earnings ----1939-40--- 1939-40 1939 1939-40 1939 1940 1939 1940

All companies (80)...... 2,056 27 8.7 8.5 142 21 40 0

Machinery (3)......... 9 296 4.6 6.4 1042 20 67 + 41 Electricalequipment (5). 45 114 8.5 9.7 632 17 57 + 17 Paper (9).............. 62 71 3.3 7.0 969 17 49 +135 Transportation (2)...... 697 39 1.4 3.0 92 31 29 +110 Miscellaneous (7)....... 105 37 12.1 10.3 144 23 47 - 14 Oil (3) ............... 161 30 15.1 13.0 120 11 24 - 13 Iron and steel (14)...... 76 27 10.3 9.5 93 25 40 - 3 Non-ferrous metals and

minerals (6) ......... 403 25 19.8 17.8 152 20 41 - 7 Textiles and apparel (9). 37 25 10.1 7.9 220 20 51 - 23 Consumer exapparel (11) 104 8 10.4 9.3 99 16 30 - 11 Utilities (11)........... 357 8 6.3 5.7 78 29 45 - 9

panies of less than five million dollars net worth. The greatest increase in net operating earnings among the very large companies-net worth fifty million dollars or more-was less than 100 per cent. Below the 200 per cent mark, however, there seemed to be little relation between the size of companies and the percentage increase in their net operating earnings.

Taxation which just, in the aggregate, drained off increased income, reduced the net profits of some companies and groups of companies and left others with larger profits than in 1939. Sharply stepped-up minimum




rates naturally reduced the profits of those companies which showed small or moderate percentages of increase in net income available for taxes; while large percentage increases in net income meant increased net profits. The paper companies, which rallied from their pre-war state of depression, the transportation group, the machinery and electrical equipment groups all showed substantial increases in net profits. All other groups showed decreases. Among individual companies (see Table II), more than half the sample, forty-four companies to be exact, had smaller

TABLE II RELATION BETWEEN PERCENTAGE CHANGE IN NET INCOME AVAILABLE FOR TAXES

FROM 1939 TO 1940 AND CHANGES IN NET PROFITS OF SIXTY-EIGHT COMPANIES*

Number of companies showing decreased, Percentage change in stationary, and increased net profits net income available

for taxes Decreased Stationary Increased Total

-20 or more........ 3 3 -10 to --19. 3 3 Down to 9.... 10 10 Up to 9............ 4 4

10-19. ............ 10 10 20-9.............. 5 1 2 8 30-9............. 1 1 2 40-9.............. 2 1 3 50-9 .............. 1 1 60-9.............. 0 70-9.............. 2 80-9............ 2 2 4 90-9 ............ 3 3

100 and over....... 2 13 15

TOTAL ...... 44 1 23 68

*Twelve companies with losses in 1939 not tabulated.

net profits in 1940 than in 1939. The decreases in twenty-nine cases of the forty-four were less than 20 per cent, in nine cases they were from 20 to 40 per cent, and in six cases from 40 to 60 per cent. One company, like the aggregate, showed the same net profit in both years. Thirteen companies showed percentages of increase varying from 1 to 50 per cent, and ten showed increases greater than this. Twelve companies which had losses in 1939 could not be included in the tabulation.

The relation between percentage increases in net income available for taxes and percentage increases in net profits showed interesting ten-




dencies. With few exceptions, only those companies which increased their net income by well over 50 per cent showed increased net profits. Four of the nine companies with increases in net income of 70-100 per cent showed decreased net profits; five showed increased net profits, only one of them, however, an increase of more than 50 per cent. Even among the fifteen companies with increases in net income of 100 per cent or more, two showed decreased net profits. Five of the remaining thirteen companies had up to 50 per cent increase in net profits, one between 50 and 100 per cent; and seven, with increases in net income of from 200 to 3000 per cent showed increases of from 200 to 2000 per cent in net profits. Naturally most of the companies showing these startlingly big percentage increases in net profits were small companies of under a million dollars

TABLE III RATES OF PROFIT OF EIGHTY COMPANIES IN

1939 AND 1940 BY GROUPS

1939 1940 Rate of profit

Number of Cumulative Number of Cumulative companies total companies total

Loss................... 12 12 2 2 Up to but not including 5

per cent.............. 14 26 14 16 5 per cent but less than 10

per cent............. 25 51 40 56 10 per cent but less than 15

per cent................ 17 68 15 71 15 per cent but less than

20 per cent.......... 7 75 8 79 20 per cent and over ...... 5 80 1 80

net worth; and the huge percentage increases represented insignificant figures in dollars-for example, from $307 net profit in 1939 to $3,665 in 1940, and from $1,290 net profit in 1939 to $26,232 in 1940. Two of the big companies with large percentage increases in net profits had been seriously depressed before the war. One owed its phenomenal increase in net profits to a large accrual of non-taxable income.

The general rate of profit based on aggregate totals for the whole group of eighty companies was slightly over 8a per cent in 1939. The net effect of increased business activity and increased taxation in 1940 was to leave this rate practically unchanged, but to modify the extreme variations in the sample. In 1939, twelve companies showed losses and the others rates of profit varying from a fraction of one per cent to 39




per cent. In 1940 only two companies still showed losses and the 39 per cent rate of profit had come down to 34 per cent. Besides the ten companies that had come out of the red, nineteen others had increased their rate of profit, ten showed a rate of profit stationary to within one per cent, and thirty-nine showed a decreased rate of profit. The regrouping of the companies as a result of these changes appears in Table III. The net result was a decrease in the number of companies with extremely low rates of profit or no profit at all, and also in those with extremely high rates of profit, and a greater concentration at the middle of the table. In 1940 half of the companies in the sample were making at least 5 per cent profit but less than 10 per cent, sixteen were making less than 5 per cent, and twenty-four 10 per cent or more. These figures compared with twenty-five companies making 5 per cent but less than 10 per cent in 1939, twenty-six making less, and twenty-nine making more. In 1940 only one company was making 20 per cent or more, compared with five in 1939. Though three of the companies which showed losses in 1939

pulled up into the 10-15 per cent category in 1940, there were few spectacular increases or decreases in rates of profit.

The changes in rates of profit by industrial groups are also interesting. The tabulation according to percentage increase in net operating earnings (Table I) clearly shows that only those groups with considerable increases in net operating earnings, that is the machinery, electrical equipment, paper, and transportation groups, increased their rates of profit. In all other groups the rate of profit, like the net profits, decreased.

The aggregate tax bill of the eighty companies in 1940 was 142 per cent greater than in 1939. Twice as large a percentage of total net income available for taxes was devoted to taxes: 21 per cent in 1939, 40 per cent in 1940. Referring again to Table I, we see that in all groups except one, taxes as a percentage of net income available for taxes increased

sharply. In the lowest group, the utilities, the percentage of net income devoted to taxes in 1940 was one and one-half times as large as in 1939; in the six next groups it was roughly double; in the three groups at the

top it was approximately triple. Only in one group, the transportation group, did the percentage decrease. The low percentage of net income devoted to taxes here and in the oil group, when the minimum tax rate was 30 per cent, may be accounted for by large accruals of non-taxable income. Under the Income War Tax Act dividends paid to an incor-

porated company by a company incorporated in Canada the profits of which have been taxed under this Act, or by a company incorporated outside Canada to the extent that the latter company has earned income within Canada and actually paid a tax in respect of such income, are not liable to taxation.




Among individual companies, the majority, forty-eight companies, devoted from 30 to 50 per cent of their net income to taxes; two companies showed losses and therefore paid no taxes; eight, for reasons such as that just mentioned, paid less than 30 per cent; and twenty-two paid from 50 to 75 per cent.

The effect of war-time conditions on the liquid position of business is another matter of importance. A study of eleven companies, all but three of fifteen millions or more net worth, and all, broadly speaking, war industries, furnishes some suggestive figures. Tracing the history of their liquid position from 1936 to 1940, we find it definitely deteriorated in 1940. Nineteen thirty-seven was also a year of lowered liquidity, since a period of expanding business is likewise a period of decreased liquidity; but the decrease was much less than in 1940. Until 1940 several of the companies each year had cash and marketable securities worth 500 or 600 per cent of current liabilities. In 1940 none had a ratio of as much as 300 per cent. Likewise in other years only two or three companies failed to have liquid assets at least equal to their current liabilities, while in 1940, eight fell below this level.

TABLE IV

LIQUID POSITION OF ELEVEN COMPANIES, 1936-40

Cash and investments as Number of companies percentage of current

liabilities 1936 1937 1938 1939 1940

Less than 100 per cent.......... 2 3 3 3 8 100-99 per cent............... 1 3 1 3 2 200-99 per cent............... 3 3 3 2 1 300-99 per cent................ 1 0 1 2 0 400-99 per cent ............... 1 0 1 0 500-99 per cent ............... 2 1 2 0 0 600 per cent and over........... 1 0 1 0 0

The situation over the whole sample, comparing 1939 and 1940, is less startling, though, as one would expect in a time of increasing business and expanding inventories, liquidity generally had decreased. Of the eighty companies, only nine had improved their liquid position appre- ciably; twenty-four had maintained it more or less unchanged; while forty-seven were in a definitely less favourable position in 1940 than in 1939. Since increases and decreases are significant only in relation to the percentages involved, a comparison of the numbers of companies enjoying varying degrees of liquidity is indicated. It is apparent from the cumulative totals in Table V that a general lowering of liquidity




had taken place. This lowering is most noticeable in the upper brackets. In 1939 the cash and marketable securities of twenty-one companies were 200 per cent or more of their current liabilities. In 1940 the number of companies in this fortunate position had been reduced to ten.

TABLE V

LIQUID POSITION OF EIGHTY COMPANIES, 1939 AND 1940

Number of companies Cash and investments 1939 1940

as percentage of current liabilities Simple Cumulative Simple Cumulative

Less than 25 per cent............ 17 17 23 23 25 per cent but less than 50 per cent 7 24 9 32 50 per cent but less than 75 per cent 5 29 10 42 75 per cent but less thanlOO per cent 13 42 12 54 100 per cent but less than 200 per

cent......................... 17 59 16 70 200 per cent and over ........... 21 80 10 80

Assuming it to be desirable that a company should have liquid assets at least equivalent to its current liabilities, 1939 saw forty-two companies below the line and thirty-eight above it; 1940 saw fifty-four below the line and only twenty-six above it. Reference to the detailed analysis behind the table shows that the decreases were for the most part not spectacular. Of the sixteen companies whose liquid assets were reduced in 1940 as compared with 1939 from a higher figure to less than 50 per cent of their current liabilities, only five had had a ratio of 100 per cent or more in 1939, and only two had been in the highly favourable position of having a ratio of 200 per cent or more. In all, five companies found their liquid assets reduced from 200 per cent or more of current liabilities to less than 100 per cent.

How serious this impairment of liquid position may be depends on future developments. A certain amount of it is due to expanded inventories which, in times of active business, are practically liquid assets. The danger lies in a sudden freezing of business activity at a period of reduced liquid assets and high inventories. If scarcities of raw materials should cause the depletion of inventories to a low level, the slowing down of activity following the war might have less serious consequences for business.

In broad outline, then, the 1940 picture was this: in the aggregate, war taxation had just drained off the increased profits caused by war stimulation. Businesses with decreased, stationary, or moderately increased incomes had suffered a cut in their 1939 profits. On the other




hand, most of the businesses with considerably increased incomes had not only preserved their previous profits intact, but were increasing them, though at a diminishing rate, as their volume increased. In 1940 these two sets of factors were just sufficient to offset each other.

In 1941, however, the situation altered considerably. In the 1940 analysis, though the decrease in net profits as compared with 1939 was strikingly apparent in the lower brackets (see Table II), it will be remembered that a small group in the upper brackets showed increased net profits. Though the companies with very large increases were few in number and their aggregate profits were not great, the fact that large percentage increases in net profits were possible was significant. The inference was that continued war-time acceleration of business might increase materially both the number of companies in this group and the aggregate amount of their profits. The raising of the flat rate of excess profits taxation on corporations in 1941 from 12 to 22 per cent, making the minimum tax 40 instead of 30 per cent, while it cut still further into the profits of industries which had not been greatly accelerated, did not interfere with the avenue to increased profits open to these highly stimu- lated businesses. As we have already seen, under 1941 tax schedules, net income had to be considerably increased before net profits equalled those of pre-war days. Beyond that point, however, though the percentage of total profits retained by the taxpayer must decrease as profits rose, it was possible for the amount of profit to increase-considerably if the business was sharply accelerated. Since the salient feature of the Canadian business scene in 1941 was the gathering momentum of the war effort, it is perhaps not surprising to find the Financial Post for January 17, 1942, quoting a business man as follows: "Excess profits taxes are now known and proving less unpleasant than at first feared. They have removed the possibility of extra high profits but increased volume of business has demonstrated that it will not be an entirely profitless war for Canadian industry." And in fact an examination of the profit and loss accounts of the eighty companies under consideration reveals that in the aggregate the increase in taxation was far more than offset by enhanced profits resulting from increased business volume.

Net operating earnings for the group as a whole were up by 33 per cent over 1940. Net income available for taxes was greater by approximately the same percentage. The tax provision of the group, which now ab- sorbed 47 per cent of net income as compared with 40 per cent in 1940 and only 21 per cent in 1939, was up by 55 per cent. Compared with 1939, net operating earnings had increased by 69 per cent, net income available for taxes by 71 per cent, and taxes by 276 per cent. Aggregate



Impact of Wcr Taxation on Eighty Canadian Corporations 577

net profits, which had shown no change from 1939 to 1940, rose 16 per cent in 1941.

Among individual companies, whereas more than half the sample had shown smaller net profits in 1940 than in 1939, only about one-fifth showed reduced profits in 1941 as compared with the previous year. To be exact: one company failed to show a profit in any of the three years; another, which had shown losses in the two previous years, made a small profit in 1941; and of the remaining seventy-eight companies, seventeen showed decreased profits and sixty-one increased profits. Table VI shows the general profits situation of these seventy-eight companies over the three-year period. It will be seen that the ten companies which came out of the red in 1940 still further bettered their position in 1941. Of the

TABLE VI CHANGES IN THE GENERAL PROFITS SITUATION OF SEVENTY-EIGHT*

COMPANIES OVER THE THREE-YEAR PERIOD, 1939-41

Change in profits situation 1939-40 Change in profits situation 1940-1

Decrease Increase Total

Decreased net profit................... 9 35 44 Loss converted to profit... ....... ......... 10 10 Stationary or increased net profit. 8 16 24

TOTAL............................ 17 61 78

*Two companies with losses in 1940 not tabulated.

twenty-four companies which maintained or increased their profits in 1940, sixteen increased them still further in 1941 and eight suffered decreases, though none of them fell back to the 1939 level. And of the forty-four companies which showed decreased profits in 1940, only nine showed a further decrease while thirty-five rallied, thirteen surpassing their 1939 performance, and twenty-two remaining below it. That is, in 1941 only thirty-one companies still had lower profits than in 1939.

This general betterment of the financial picture is likewise obvious in the analysis by groups given in Table VII. As in 1940, increases in net operating earnings took place in all groups. The percentage increases were, naturally enough, smaller than the previous year in the groups which had been sharply accelerated during the first full war year, notably the machinery, electrical equipment, and paper groups. They were definitely larger, however, in some of the groups which had expanded more moderately in 1940. In the iron and steel, non-ferrous metals and




minerals, and transportation groups the greater expansion was obviously due to the growing intensity of the war effort. In the last three groups, it indicates that war stimulation had increasingly affected non-war as well as war industries.

The combined effect of two war years upon net operating earnings appears in column two of Table VII. The three groups definitely com-

posed of war industries, the transportation group, and the paper group had at least doubled their net operating earnings as compared with 1939. The miscellaneous, oil, non-ferrous metals and minerals, and textiles had increased them by approximately 70 per cent, and the consumer and utilities groups showed comparatively modest increases of 32 and 22

per cent. TABLE VII

CHANGES IN TAXES, PROFITS, AND DEPRECIATION CHARGES OF EIGHTY COMPANIES FROM 1940 TO 1941 AND FROM 1939 TO 1941,

BY INDUSTRIAL GROUPS*

Per Per cent cent increase Per cent 1941 Per cent Per cent in net change in net increase change

Industrial Group operating depreciation income in tax in net earnings chargest de- provision profits

------- ---voted---- 1940- 1939- 1940- 1939- to 1940- 1939- 1940- 1939-

41 41 41 41 taxes 41 41 41 41

All companies (80) . 33 69 + 47 + 62 47 55 276 +16 + 16

Machinery (3)... 100 690 + 77 +390 72 117 2382 +75 +146 Electrical equiplnent

(5)............ 76 277 + 50 + 84 70 113 1459 +21 + 42 Paper (9)......... 21 106 + 4 + 39 60 82 1842 +14 +167 Transportation (2) . 51 110 + 16 + 62 35 130 342 +70 +257 Miscellaneous (7).. 23 68 + 46 + 59 49 30 218 +17 + 1 Oil (3)........... 31 70 + 14 - 10 36 65 265 - 8 -20 Iron and steel (14) . 69 115 +110 +221 54 100 286 +18 + 14 Non-ferrous metals

and minerals (6) . 34 68 +111 +126 46 38 247 +10 + 2 Textiles and apparel

(9)............. 34 67 + 6 + 29 56 57 403 +30 0 Consumer ex apparel

(11)............ 22 32 + 8 + 28 38 59 216 + 7 - 5 Utilities (11)...... 13 22 + 18 + 23 50 33 137 + 6 - 4

*The arrangement of Table I has been preserved for purposes of comparison. tSeventy-seven companies, one being omitted from each of the transportation,

miscellaneous, and iron and steel groups.




Though there were none of the conspicuously large percentage increases in taxes that had marked 1940, gains over the previous year were still substantial. In all but three groups-the miscellaneous, non- ferrous metals and minerals, and utilities-tax provision increased by more than 50 per cent; and in the three groups of war industries and the transportation group it at least doubled. Compared with 1939 even the group which showed least acceleration, the utilities, had more than doubled its tax provision. As a general rule taxes had tripled or quad- rupled, and for the three groups at the top had multiplied hugely. These huge percentage increases, it should be noted, are largely due to the fact that a number of companies in these three groups were depressed in 1939 and made little or no tax provision, so that the group tax figures were abnormally low in that year.

Percentage of net income devoted to taxes had increased all along the lint. The machinery and electrical equipment groups in 1941 devoted approximately 70 per cent of their net income to taxes, the paper, miscellaneous, iron and steel, non-ferrous metals and minerals, textiles, and utilities groups 45-60 per cent, and the oil, transportation, and consumer groups 35-40 per cent.

Despite substantial increases in taxes, however, the profit situation of the group was definitely more favourable than it had been in 1940. Where seven of the eleven groups had shown decreases in profit from 1939 to 1940, all except one increased their profits in 1941 as compared with 1940. Aggregate profits were up by 16 per cent. Increases for individual groups ranged from 6 and 7 per cent for the utilities and consumer groups to 30 per cent for the textiles group, and 70 and 75 per cent for the transportation and machinery groups respectively. The comparison of 1941 with 1939 shows that only three groups-the oil, consumer, and utilities- failed in 1941 to show profits at least equal to their 1939 profits. The textiles, non-ferrous metals and minerals, and miscellaneous groups equalled or slightly exceeded their 1939 performance. The iron and steel group-showed an increase of 14 per cent, the electrical equipment group one of 42 per cent, while for the machinery and paper groups profits were well over double and for the transportation group well over triple what they had been in 1939.

Two special items which, though they are accepted as legitimate deductions for tax purposes, nevertheless make war-time profits not fully comparable with peace-time profits, must at least be mentioned. These are inventory reserves and special depreciation allowances. Eleven of the eighty companies in the sample put away inventory reserves in one or both of the years 1940 and 1941, though in two cases the amounts of such reserves were not specified and therefore could not be included in




calculations. The total amount of specified reserves was $4.3 million in 1940 and $8.2 million in 1941. In the aggregate, these amounts are not significant; but in individual cases and even in the groups to which these companies belong, they constitute a not unimportant element in the financial picture. Particularly is this true of the oil group, where one company in 1940 and all three companies in 1941 put away substantial amounts under this heading.

Depreciation write-offs for seventy-seven companies (three companies failed to specify the amount of this item in their published reports) were roughly $98 million in 1941 as against about $67 million in 1940 and $61 million in 1939, an increase of 47 per cent over 1940 and 62 per cent over 1939. (See Table VII.) All groups increased their charges in 1941 and in only one group, the oils, were they less in 1941 than they had been in 1939. The over-all percentage increases from 1939 to 1941 were modest in the predominantly civilian industries, substantial in the transportation, miscellaneous, and electrical equipment groups, and striking in the non- ferrous metals and minerals, iron and steel, and machinery groups; where they amounted to 100, 200, and nearly 400 per cent respectively. Ob- viously, these last three cases are explained by special war allowances which permit industry to write off old equipment at an accelerated pace and to pay for new plant and equipment out of untaxed war-time profits. Where plants are working two shifts, the ordinary depreciation allowance for machinery of 10 per cent is increased by the War Contracts Depre- ciation Board to 15 per cent. Where they are working three shifts, it is increased to 20 per cent. Companies which build new plant may ask for special allowances, which are calculated on the basis of usability after the war. If the residual value, that is the estimated usefulness of the plant to the company in the post-war period, is calculated at 25 per cent, this is to be written off at the regular 10 per cent rate, the remaining 75 per cent in two, three, or four years. If the plant is considered to have practically no residual value, almost the entire cost may be written off in two, three, or four years, depending on the type of goods and their usability. Under the War Exchange Conservation Act of 1940, the Mlinister of Finance may give special depreciation allowances for plant expansion to companies which will thus bring into Canada increased amounts of foreign exchange. Under such an arrangement, for instance, Great Lakes Paper Company of Fort William is being granted for taxation purposes a special depreciation allowance amounting to one-third the cost of new depreciable assets during each of the three years 1941, 1942, and 1943. International Nickel, in a $34 million expansion programme, expected to bring in $15 million in U.S. exchange over a five-year period, is being granted cumulative depreciation deductions to reach a total of




$25 million at the end of 1945. These heavy deductions obviously alter the profit and tax picture. Aluminum Limited, for example, though its net profits went up only $31 million in 1941, increased its normal depreciation charges by nearly $2 million and deducted special depreciation in respect of war facilities amounting to nearly $12 million. A small company which showed a decrease in profits of $23,000, increased its depreciation allowance by $210,000, making it more than three times what it had been the year before. Whether these high depreciation allowances may not in the long run work to the undue advantage of industry is a matter for debate. Certainly if the war ends just when the new assets have been written off, the companies will be the gainers to the extent that the assets continue to be usable, since they will have had heavy exemp- tions during a period of high tax rates. (The balancing consideration here, of course, is that, if the war and war taxation continue after the assets have been written off, the companies will then be at the disad- vantage of having no depreciation deduction in respect of them'.) But whether they are considered to be excessive or whether they are considered to be legitimate costs, justified under the abnormal circumstances of war when industry must undertake expansion that may be a definite handicap to it in the post-war period, they must certainly be taken into account in any evaluation of the immediate profit situation.

Evidence, then, would seem to indicate that 1941 was a definitely more profitable year than the previous one. Nevertheless, uncertainty about the future, fear of post-war dislocation, the spectre of catastro- phically falling prices and glutted inventories undoubtedly condition business policies at this juncture. One obvious instance is the conser- vative dividend policy being generally pursued by Canadian business. Frequently, even when profits per share have been doubled or more than doubled, only the normal dividend rate is being paid. Dividend payments in Canada in 1940, according to the 1942 Financial Post Business Year Book, were about $305 million, slightly less than in 1939. In 1941 they were somewhat under $317 million, an increase of less than 4 per cent. And it must be remembered that in both 1940 and 1941 a number of companies whose dividend payments had lapsed resumed payment.

The increased working capital necessary for a larger volume of business and expanded plant capacity partly explains this reluctance to increase dividends. Cash requirements have grown with heavy inventories and enlarged output. Companies are seeking to do their own financing to avoid the large bank loans with which many of them were caught at the end of the last war. In other words, increased profits, where they exist, are for the most part being ploughed back into the business to strengthen its financial position, instead of being disbursed as dividends.




Business would like to cushion itself still further against the future by obtaining a more liberal interpretation of the inventory reserve provision than the Income Tax Division has seen fit to grant. On November 13, 1941, a committee from the Dominion Association of Chartered Ac- countants waited on MIr. C. Fraser Elliott, the Commissioner of Income Tax, to request, among other things, that the words, "a normal quantity of stock in trade necessary for the business," be read apart from the words, "as indicated by quantities on hand during the standard period," so that an ever-expanding war-inventory might be considered "normal" and be protected by a tax-free inventory reserve. The authorities, however, although they brought down a ruling in November, 1941, that, in allowing inventory reserves, consideration would be given to normal increase in inventories caused by bringing additional machinery into operation, have remained adamant in their decision not to allow pro- tection for heavily expanded war-inventories due to extended hours or speeded methods of production of pre-war machinery.

In a letter to the Secretary of the Dominion Association of Chartered Accountants published in the Canadian Chartered Accountant for De- cember, 1941, M/r. Elliott observes:

If... a reserve against increasing amount of inventory were to be allowed, it would be an invitation to the companies to say: "Rather than handing a substantial

portion of our profits to the Crown, let us buy yet more inventory"-perhaps having in mind yet further increases in cost, and thus create claims for greater and greater reserves, and thereby enforce the Crown to invest its substantial portion of the profits in inventory and thus risk the Crown's money in a precipitous decline of inventory. .. The denial of such reserve certainly requires all businesses to be very cautious and not over-extend their inventory, because they realize that they are risking their own money.

That some businesses would also like to put themselves in a more favourable financial position by getting concessions in the matter of "standard profits," the yardstick against which excess profits are mea- sured, is shown in certain remarks of M/r. Justice Harrison, Chairman of the Board of Referees, speaking before the Ontario Division of the Canadian Bar Association. An argument advanced by some taxpayers applying for a standard profit higher than that actually earned during the years 1936-9 is "the claim to recoup out of profits the amounts necessary to compensate for past lean years and possible future lean years." This argument, the speaker stressed, was considered irrelevant by the Board. Remembering that the vast majority of taxpayers have not the oppor- tunity to come before them, they consider it their duty to set the standard profit at a figure that could actually have been earned under the business conditions prevailing in 1936-9 if the taxpayer had been in business or had not been suffering from special difficulties, so that all taxpayers may




feel that their standard profits represent an amount that was actually earned or could have been earned in 1936-9.

Comparisons have often been drawn between the British 100 per cent excess profits tax and the 75 per cent Canadian tax. Those who made such comparisons were not always aware that 20 per cent of the British tax is in the form of compulsory savings, to be returned to the taxpayer after the war. The discrepancy between the two was, therefore, more apparent than real, and since the imposition of the most recent budget even the apparent discrepancy has disappeared. The Canadian tax has been heavy and its application rigorous. If, however, as evidence seems to indicate, these taxes were no longer siphoning off war profits, the reason for the changes introduced in the new budget becomes clear. While profiteering has been prevented and legitimate profits restricted though by no means stopped, little actual sacrifice has yet been asked of business. An article in the Financial Post for January 17, 1942, dis- cussing investment trends says: "To date it must be admitted there is little evidence from published reports that payment of taxes has weak- ened the working capital strength of Canadian companies." What the situation may be in the future depends on the complex forces at work in the Canadian war economy. The lower unit costs of production conse- quent upon greater utilization of plant capacity which were a major factor in the increased earnings of, say, the newsprint industry in 1941 will tend, with increasing curtailment of non-war industry, growing scarcities of raw materials, and the difficulties of getting high quality labour, to increase, thus reducing profits. The "squeeze" from the price ceiling will likewise tend to restrict profits. Finally the new tax schedules, operative on the second half of 1942 income, will make it impossible for any corporation to retain more than 70 per cent of the amount of its standard profits-though a portion of the tax will be returned after the war and incentive to increased output will take the form of building up this post-war credit. The effect of these new factors is a matter for speculation not unmixed with apprehension in the business world. The natural desire of business is to emerge from the conflict in a sound financial position. How far the realization of this desire is compatible with the effort necessary to defeat totalitarianism in a world-wide war is problema- tical. In an all-out war effort, as Mr. Donald Gordon has said, the objective is "maximum production, regardless of vested interest and without too much concern about long-term effects .... Selfish or private interest must be ruled out completely."

Lucy MORGAN

Toronto.



the impact of war taxation on eighty canadian corporations

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