A dubious distinction with a weighty impact
Thursday 12 October 1995
All these schemes involve entirely legitimate use of the existing tax system - but on a scale and in a way that was surely not anticipated by officials. The basic principle is simple enough: cash payments by companies to tax-exempt institutions among their shareholders are topped up with a tax credit. This seems entirely reasonable in the ordinary course of dividend payments. But when it involves very substantial repayment of capital, sometimes linked to a takeover bid, it is open to abuse. With a special dividend, institutions claim a tax credit that increases the value of the payout by 25 per cent. On the face of it, this is a ridiculous and unjustifiable subsidy that threatens to drain billions from the Treasury as companies and their advisers catch onto it.
But the problem, as the Institute for Fiscal Studies pointed out in its Green Budget, is that there is no way of making a sensible distinction between an ordinary and a special dividend - the name of the latter is simply a way of indicating that it is a one-off. Banning them would simply switch corporate effort into something else. Buybacks are even more tax- effective. Sadly, there may be no easy solution. The tax benefits are rooted in the longstanding use of advance corporation tax. This is a misnomer. ACT is in fact an advance payment of shareholders' income tax, and that is why tax-exempt institutions receive a credit on their dividends.
The only sensible way for the Chancellor to get out of this hole without causing chaos is to reform the taxation of dividends to remove the distortions caused by these credits. But when Stephen Dorrell flirted with the idea last year while at the Treasury he was jumped on from a great height.The market's reaction to Norman Lamont's pounds 1bn raid on the institutions' tax credits in the 1993 Budget had already signalled the dangers for a Tory government of tampering in this area. The chances of Kenneth Clarke having another go appear slim, but reform is overdue.
Lloyds' techno love-in with TSB
Sir Brian Pitman, chief executive of Lloyds, hardly comes across as an archetypal techno-freak, but in business today you have to be. Information technology, and the competitive advantages it can bring to retail banking, is one of the main driving forces behind the proposed link-up with the TSB. That and size. Sir Brian believes that success in the UK retail financial services sector, where the opportunities for growth are slim and margins even slimmer, is increasingly about leveraging size.
With this deal, Lloyds and TSB hope to have stolen a march on their rivals by achieving, at a stroke, a much bigger branch network and customer base along with considerable scope for paring back costs. But that of course is the rationale behind all such big mergers. The hard part is pulling it off.
Technology will play a decisive role here. Sir Brian becomes almost delirious when describing the competitive edge of Cheltenham & Gloucester's information retrieval system, which Lloyds is now applying throughout its mortgage business. Now the idea is to take the best banking IT system, probably the TSB's, for the combined group. The potential for back-office savings, by extending an already developed system, would be significant, possibly worth more than pounds 100m a year by itself. The elimination of duplication in back-office and headquarter staff and functions, before even getting onto the branch network, suggests that Sir Brian and his TSB counterpart, Peter Ellwood, are, if anything, being rather cautious on the cost-saving potential.
Rather than the pounds 350m of annual savings, or 9 per cent of the combined cost base, that they are talking about, the real potential may be closer to pounds 500m a year. No wonder many analysts expect the combined animal to achieve a stock market valuation of pounds 15bn. To see the potential just take the combined present stock market value of the two companies, pounds 13bn, subtract the pounds 1bn special dividend, and watch the upside.
Assuming it can be got through the competition authorities, this is a superb deal for Lloyds. The geographical fit, with TSB's Northern and Scottish bias complementing Lloyd's Southern stronghold, suggest that the branch reductions may not have to be severe. The strength of the fit, and the fact that Sir Brian and Mr Ellmore are having the banking equivalent of a love-in, makes the task of any late rival bidder pretty difficult. The agreed nature of the bid, and the fact that Lloyds/TSB will not have a dominant share of any market, should reduce the chances of an MMC referral.
NatWest gears up for Gartmore
Sir Brian Pitman is not the only one with a glint in the eye. The boys from NatWest are on heat again. They are to be found serenading ardently beneath Gartmore's balcony. Twice recently they have lunged up the aisle, only to see Barings and Warburg carried off by a rival suitor. Will it be third time lucky? NatWest is impatient to push on with its plans to be a global investment banking powerhouse. The money is there and it intends to use it. There is no talk of a share buy-back at the top of NatWest. Once the sale goes through of Bancorp, NatWest's retail banking operation in the US, the war-chest will be brimfull. Reading the runes, NatWest is preparing for purchases on both sides of the Atlantic. There appear to be three thoughts driving NatWest strategy. Strong corporate finance brings essential value to a securities house. A large fund management operation enhances the profitability of a bank's retail business. And to win global investment banking deals you must have a strong presence in the US.
Gartmore would fit NatWest's fund management needs admirably, despite the fancy prices on demand these days. Corporate finance in London poses more of a problem, mainly because there are few eligible partners. NatWest Markets presents an uncomfortable imbalance, with a strong equities business and a corporate finance side still scarred by the traumas of County. It is to the US, however, that shareholders will be looking nervously. It has proven a graveyard for British investment banks. But those with global ambitions realise that there is no half-hearted approach to New York. This applies equally to BZW, Deutsche, SBC and UBS. The only question is who moves first. NatWest, which already has the biggest US equities operation among foreigners, appears to be mulling either buying a medium- sized securities house, or a joint-venture, buying part of a US firm or setting up a new partnership. Investors should brace themselves.
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