Money: Get ready for an upset

Corporation tax changes could be on the way. Don't imagine this doesn't concern you
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City commentators are to be pitied. Really. We live in a no-win world. Tell people a share like Norwich Union is likely to open at a healthy 85p premium over the application price for members cute enough to borrow from their banks and add to the discomfiture of the institutions, and we are accused of hyping the market. Watch the shares plummet soon afterwards, and your audience is full of "I told you so" expressions. Well, they did plummet. In this case it really was not our fault. Honest!

Last weekend, on the eve of the Norwich Union debut, we City commentators were pretty evenly divided. On the one hand you had those who felt the whole circus was running far too fast. Sell on receipt of your certificate was the advice. Strangely the more moderate voices came from those who were recommending hanging on. Abbey National was referred to more than once as an example of what these demutualised businesses can deliver to shareholders if you have patience.

As it happens, Norwich Union had a stormy admission to stock market listing. Yet the peaks and troughs had far less to do with perceived value for Britain's third-largest life assurer than worries over the Budget. And in particular that old bete noire of the investment management industry, advance corporation tax (ACT).

Time for a Tora tax teach-in. Advance corporation tax, as I have said before, is one of those strange taxes where the more it is cut, the more the Treasury gains. It is the system whereby companies pay the tax due on the dividends they declare on behalf of their shareholders. For the bulk of us this means that either no additional tax is payable, or we simply suffer the difference between the present 20 per cent rate and the 40 per cent top rate of tax.

For pension funds, charities and personal equity plans, the situation is somewhat different. As this tax is deemed to be paid on behalf of these investors, a tax-exempt fund is now able to reclaim the tax paid and thus "gross up" the value of the dividend they receive.

What difference does this make to the average investor? Quite a lot actually. It might affect you as a PEP holder, a member of a pension scheme or even as a straightforward investor in UK shares. The consequences of cutting, or perhaps even eliminating, ACT are enormous.

The biggest single group of investors in the UK are the pension funds. They currently account for more than a third of all the shares owned in the UK market. When you add to that PEPs, charities and other non-tax- paying funds, you arrive at around 40 per cent of all British shares - double the amount held directly by private investors. Many of these holders of domestic equities rely upon the dividend stream to meet their obligations or to provide an appropriate return to fund their activities.

Take pension funds, for example. Actuaries calculate how much return is needed to meet the liabilities of the fund. A part of this expected return will be from the tax credit on dividends. Restrict that flow of money and you could see companies needing to compensate by topping up their pension funds out of corporate profits. Now that could influence how shares are rated.

Nobody really knows what the real effect would be to pension funds of the elimination of ACT. Guesstimates range around 2-3 per cent of their total return. It may not sound much, but it is probably a sixth or so of the average total return each year.

Replacing that could be a problem. It will almost certainly mean lower prices for shares in the short term.

It could also have an effect on how pension fund assets are deployed. Much debate continues over how much should be committed to gilts as opposed to equities. A lower level of ACT will make gilts that much more attractive, so perhaps the switch in asset allocation will be accelerated.

Pension funds are are not the only part of the investing universe that will feel the impact. Charities will have less money to spend. PEPs will grow at a slower rate than hitherto.

So, when the Chancellor announces a change to ACT, do not think that this is a tax change that has no relevance on you. It will affect how big players in the market allocate their funds. It will influence the flow of money into the stock market. Most importantly, it will mean an immediate downgrading of equities against other types of investment. Snap Budgets are usually not good for the market. Next July could be no exception.

Brian Tora is chairman of the Greig Middleton investment strategy committee and can be contacted on 0171-655 4000.

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