Kenneth Clarke, the Chancellor, shut the door on the benefit, which he claimed was costing the Exchequer pounds 400m a year in unpaid tax. The move was widely criticised by tax experts and companies alike as "overkill" and described as no more than political point scoring on the first day of the Tory Party conference.
Reuters said yesterday it had decided to put off the planned repayment of most of its pounds 850m cash pile until it had had a chance to study the changes which will be detailed in the Finance Bill following this year's Budget. Its complex proposal had envisaged a phased repayment of 37.5p a share combined with a 5 per cent reduction in the company's share capital.
Although not mentioned by name in the announcement, the clampdown is understood to have been prompted by Reuters' proposed scheme, which was to be voted on today by shareholders. Mr Clarke is thought to view it as the final straw at the end of a series of buybacks and special dividends that have transferred pounds 7bn from companies to their shareholders so far this year.
Mr Clarke said yesterday that gross funds would no longer be able to claim tax credits on either share repurchases or special dividends that were linked to other transactions such as share consolidations and takeovers. Reuters' plan, which involved a share consolidation designed to return cash to shareholders while still maintaining the group's earnings per share, is the first victim of the changes and its shares closed 22p lower at 755p. Other companies, such as Barclays, which had indicated its willingness to pay cash back to shareholders in this way, will be caught by the ban.
Other recent transactions that would not be possible under the new rules include a pounds 458m special dividend used by Granada to sweeten its offer for Forte. A similar 40p-a-share special payout in this week's offer from SHV for Calor is now under threat.
Mr Clarke said yesterday: "We have seen recently companies buying their own shares or paying special dividends in such a way that the proceeds end up almost entirely in the hands of those who are entitled to payment of a tax credit. This has costs for the Exchequer, and if action is not taken soon that cost would escalate. I therefore propose to bring forward legislation in the next Finance Bill to remove payable tax credits in some circumstances."
He added: "The Inland Revenue will continue to monitor the situation, and we will not hesitate to take any necessary further action should further evidence of abuse appear."
The changes proposed by the Chancellor mean that although the affected special dividends and share repurchases will still qualify as distributions of profits, and oblige the companies making them to pay the associated advance corporation tax to the Revenue, they will no longer give the recipients the right to claim that tax credit back.
One senior tax accountant described the move as a deliberately complex way of raising revenue without risking a politically dangerous all-out attack on pension funds. He said it represented a "shot across the bows" which would warn the funds that their current tax privileges, including tax-free ordinary dividends, were not sacrosanct.
After initial consternation on the stock market, analysts said closer scrutiny of Mr Clark's proposals revealed only a "very small negative". Steve Wright, equity strategist at BZW, said the closing of the loophole did not necessarily mean the end of the share buyback, which remained an attractive way for companies to reduce their capital base. Ordinary special dividends, not linked to other transactions, are unaffected and remain an option for cash-rich companies such as the utilities to hand excess funds back to shareholders.
He added that some companies, mainly high yielders, might benefit from the move, which would encourage investors to replace the high levels of income they have gained from the pounds 7bn of recent repurchases and special dividends. Railtrack, Hillsdown Holdings, BAT and United Biscuits rose yesterday.
Others were more critical of the proposed changes. Roger Muray, a partner at Ernst & Young, said: "This move has wide-ranging effects. It will be a major impediment to over-capitalised companies returning cash to their shareholders. Ordinary share buybacks, which do not specifically target tax-exempt shareholders should have been left outside the net."
Simon Laffin, finance director at Safeway, which returned pounds 208m to shareholders earlier this year, said: "The Chancellor hasn't thought through why companies do these buybacks. They are trying to reduce the cost of their capital so they can invest more. He is attacking the competitiveness of British industry."
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