The death of advance corporation tax last week left much of the business world celebrating, but not London’s equity markets.
While many support the removal of a fiendishly complicated part of the UK’s tax legislation, others say its demise has contributed to a drive towards debt which could hurt London’s leading position as a financial centre.
This process first started when, almost two years ago, the government removed the right of pension funds to claim repayments of ACT, which was paid by companies with dividends and then clawed back against mainstream corporation tax payments.
This move provoked anger from the pension industry, which argued it was a stealth tax on the funds of hardworking British workers saving up for their old age. The issue remains, although the anger has subsided with time.
But, according to John Rogers, of the National Association of Pension Funds, this change has had another effect – pension funds are now investing less in equities and more in bonds as equities have become relatively less attractive.
As a consequence, debt has become a more attractive way of financing for companies, particularly as interest can be deducted from taxable profits. Dividends are paid out of post-tax profits.
Plunging interest rates have only served to make debt even more attractive for companies, and many are increasing their gearing as debt becomes a more efficient, and therefore important, part of a company’s financing structure.
These factors have caused much of corporate Britain to embark on a mission to reduce its equity. Share buybacks are suddenly all the rage, with the term ‘cash-back’ creeping from the supermarket till onto the financial news pages.
Big names, such as Halifax, Centrica, Tomkins and Woolwich, are among those who have pledged to hand money back to their shareholders.
Many have been held back, until now, by the fact that they still faced the possibility of paying ACT on these payments.
‘What the abolition of ACT now does is take away one of the costs of getting rid of equity,’ according to Ernst & Young tax partner Rosalind Upton.
More companies can therefore be expected to reduce their equity and increase their debt funding. More share buybacks and ‘special’ dividend payments could be on the way.
But while cheap debt may provide companies with a more efficient way to finance themselves, some have expressed concerns about the impact of this on the equity markets and the liquidity of the companies themselves.
One investment adviser said: ‘If you reduce equity business you reduce liquidity. One of the things that made London the financial centre it is today is this significant liquidity and the equity markets. The demise of ACT means disattraction in a market which is already contracting because of low interest rates.’
According to Upton, however, the threat to equities is overrated. ‘I cannot see the stock market ending because there is always a balance between debt and equity,’ she says. ‘It’s not that long since everyone was worried that gearing was too high.’
Others argue that cashbacks will put more money in the hands of investors to invest in other equities, thus contributing to the health of the market.
The fact that companies are focusing more on debt in their financing, they say, is merely a reflection of the fact that this is now a cheaper way to finance, and is therefore a sign that companies are being run efficiently.
The days are gone, pundits observe, when sleepy boards could let cash piles rot for ages on their balance sheets.
The drive to return cash to shareholders, however, may not be entirely free of problems, despite the death of ACT.
Upton warns that the Inland Revenue is looking carefully at share buy-backs as civil servants are worried about the effect on corporation tax. The fact that interest can be deucted from taxable profits means that the more debt a company has, the lower its corporation tax bill.
By getting rid of ACT, therefore, chancellor Gordon Brown may in some respects have scored something of an own goal as the drive to debt could reduce the exchequer’s corporation tax yield.
Some see signs that the Revenue is beginning to adopt a get-tough attitude towards share buy-backs and could invoke anti-avoidance legislation or disallow the tax deduction for interest payments.
Others fear the Revenue will go further, and impose new sanctions to stem the potential fall in its income. Despite the demise of ACT, however, reports of the death of the equity market seems somewhat premature.
BUSINESS REACTION MIXED
The death of ACT will make dividends more attractive to owner-managers, according to Frank Haskew, of the English ICA’s tax faculty.
While it still existed, many such people drew a salary instead of taking dividends from their companies. For many, dividends will now become an easier option.
Feelings are mixed. ‘Its demise has removed a major complication in corporation tax rules,’ he says. ‘People can’t quite believe ACT has gone.’
Larger companies, however, face the new and complicated burden of making tax payments on account under the tax self-assessment system, involving a cashflow disadvantage and the near-impossible challenge of estimating annual profits halfway through the year.
The government hopes the new payment on account system, which applies to companies and groups with annual profits of more than #1.5m, will compensate for the cashflow disadvantage it will suffer as a result of the end of ACT.
CONTROVERSY DOGS DEMISE
Boasting that the change would give small and medium-sized companies a cash-flow advantage of about #1bn, the government trumpeted April’s abolition of advance corporation tax in last year’s Budget.
At the time, chancellor Gordon Brown said: ‘The abolition of ACT and the modernisation of the corporation tax payments system are important elements in the drive for simplicity and fairness.’ In particular, Treasury officials added, ‘companies will no longer face the threat of generating surplus ACT as a result of cyclical movements.’ Since then the change has been dogged by controversy. The new shadow rules – promised in last year’s Budget statement – were delayed until February, seriously hampering British business’ attempts to use up its collective #7bn ACT surplus.
Even now, tax experts warn the limited relief might only be temporary as their existence has been guaranteed until the end of the current parliament.
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