Corporate Taxation - Act now

The government has said so little about the abolition of Advance Corporation Tax (ACT) that even accountants have been confused.

There is considerable misunderstanding of the proposals for the alterations in the corporate tax system, and businesses need to give it some serious thought. In his pre-budget statement of 25 November 1997 Chancellor Gordon Brown said only: ‘To allow companies to plan ahead I can confirm today that, in April 1999, advance corporation tax will be abolished.’ It was a long warning but with little information.

The only further guidance was in the consultative document issued on the same day, which made clear that the present tax credit of 10%, as recently passed in Finance (No. 2) Act 1997, would continue in force.

In fact, the change is dramatic. From April 1999, a company paying dividends will make no payment at all to the Inland Revenue in respect of tax, nor will it deduct any money from the dividend declared when it is paid to shareholders.

As a consequence of this, no ordinary personal shareholders (otherwise subject to the burden of income tax) would become liable for any increase in taxation liability. High-rate taxpayers would be granted a tax reduction on the dividend income. By reducing the added-on tax credit from a quarter to a ninth the ‘gross’ income has dropped and so the charge to higher rate tax payers will have dropped (Table 1).

A tax credit of one ninth of the actual dividend paid will continue to attach to dividends, giving a tax liability of 10% on the gross income.

But this credit remains purely notional, in that there is no intention that the dividend-paying company would either deduct any monies from the payment being made to the shareholder or make any payment in that respect to the Revenue.

It is difficult to equate these changes with the tenor of press comment.

As an example, Ann Robinson of the National Association of Pension funds, wrote in the Guardian on 26 November that ‘the abolition of advance corporation tax takes us back to the corporate tax system we had over 30 years ago’.

The reality is that it is proposed that we retain an imputation system where the profits of the company and its dividends are regarded as one source of income, so that the corporation tax paid will represent also the basic rate tax liability of the shareholder.

There will be no return to the classical system, where the profits of the limited company and the dividend paid to the shareholders were regarded as two completely separate sources of income and where the company deducted the tax from the dividend and handed it over to the Revenue.

No dividend recipient will be entitled to receive a repayment of the tax credit because of his personal circumstances. The argument suggested in support of this is that such repayment would allow a company to reduce the overall tax charge payable to the Exchequer by the payment of dividends.

UK companies receiving dividends from other UK companies will continue to be free from any corporation tax charge on the dividend income. But it will also continue to be tax advantageous for smaller limited companies to pay employee shareholders (including directors) dividends rather than salaries.

The professions and the business community have not adjusted to the release of long-term proposals. The Treasury gave 16 months’ notice of the proposals, but the delay by the professional and business communities in discussing them took up most of the time available for comment to the Treasury.

With the consultation period ended 30 January, businesses and their advisers had better start preparing sooner rather than later for the change.

Ron Altshul is senior lecture at Sunderland Business School