HC Deb 16 March 1993 vol 221 cc185-7

In discussions with business organisations over the last few months, one issue has come up again and again—the problem of surplus advance corporation tax, or ACT. Many believe that this feature of our tax system both penalises successful British-owned international companies and distorts investment decisions.

This issue has, of course, been with us for many years, and it has so far defied solution. Nonetheless, I made a commitment in my Budget last year to return to this subject, and I am pleased to be able to report to the House that I have now found a way forward.

I hope that the House will bear with me, as I am afraid that my proposals are complex, but they do attack the problem of surplus ACT, they are central to the strategy of this Budget, and they raise significant amounts of revenue.

At present, ACT is paid on dividends at 25 per cent. This funds a tax credit which covers the basic rate income tax bill of the shareholder, but, as its name implies, it is also an advance payment of the company's corporation tax bill.

In normal circumstances, the system works very well, but sometimes it does bring problems, particularly for companies which earn a large proportion of their profits overseas. These companies often end up paying an ACT bill on their dividends that is greater than their entire United Kingdom corporation tax liability. The so-called "surplus ACT" that results cannot be claimed back, so in effect it becomes an extra tax on profits.

This can have damaging economic effects. For example, it gives some companies a strong incentive to move important activities, including research and development, abroad, leading to the loss of skills and jobs in this country. It cannot be right to distort the commercial decisions of British companies in this way or to give companies a positive incentive to move elsewhere in Europe; so today I am putting forward some proposals that will go a long way towards alleviating the problem.

First, I shall establish a special tax regime from 1994–95 to help foreign-owned international companies which are considering setting up their headquarters in the United Kingdom. This will make it more attractive for international companies to base their operations in Britain, and it will further promote London's position as Europe's leading financial centre.

Secondly, I am today issuing a consultation document proposing a scheme under which British companies may choose to class any dividend paid out of overseas profits as a "foreign income dividend". Unlike normal United Kingdom dividends, this will not carry any tax credit, and although ACT would initially be payable in the usual way, the company will be entitled to a refund if it gives rise to surplus ACT. Once fully operational, this scheme could reduce the build-up of surplus ACT by some £250 million a year.

Finally, I have one further proposal which will help not just companies with surplus ACT, but all dividend-paying companies; and it will do so in a way that will raise considerable revenue. I propose simply to reduce the rate of ACT in two stages, from 25 to 22½ per cent. in 1993–94 and then to 20 per cent. in 1994–95. This will give companies which pay dividends a cash flow benefit of about £2 billion over the next two years, and it will reduce the build-up of surplus ACT by about £300 million next year.

I also propose to reduce from 25 to 20 per cent. in 1993–94 the tax credit that shareholders get when they receive a dividend.

Those who are familiar with these issues—a select few, I fear—will know that tax credits affect two main groups of shareholders. Those with no tax liability, particularly pension funds, can claim a cash payment from the Inland Revenue for the tax credit, and higher rate taxpayers have to make up the difference between the 40 per cent. top rate of tax and the 25 per cent. tax credit they receive.

The reduction in the tax credit that I am proposing will therefore have two important effects. First, the payments that lower rate payers, non-taxpayers and particularly pension funds, get from the Inland Revenue will be reduced by five percentage points, saving the Exchequer no less than £1 billion a year. Secondly, higher rate payers will have to pay an extra 5 per cent of tax on the dividends they receive in order to discharge their liability to tax at the top rate of 40 per cent. This, in turn, will yield an extra £200 million a year.

Finally, in order to ensure that most ordinary shareholders are not affected by this change, I propose to reduce the rate of tax on dividends from the current basic rate of 25 to the lower rate of 20 per cent. The effect of this, combined with the change to the tax credits, is to leave basic rate taxpayers neither better off nor worse off than they are now.

Thus, these proposals achieve three objectives at the same time. They will give companies a £2 billion cash flow boost over the next two years, they will significantly reduce the problem of surplus ACT for the future, and they will raise £900 million extra revenue for the Exchequer from 1995–96 onwards.

There is, however, one group for whom I believe it would be desirable to ease the immediate effect of these changes. I therefore propose for charities to phase in the effect of the reduction in the tax credit over a four-year period. I also have some further measures for charities, to which I shall turn later.

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