COMMENT: Why Brown needs to rethink corporation tax

`As a direct result of Gordon Brown's Budget measures, we are now faced with the prospect of one of the most unfair corporate taxation systems anywhere in Europe'

Britain now has the lowest rate of corporation tax of any of our main competitors, and, at just 31 per cent, the lowest rate ever in the UK, Gordon Brown proudly announced in his Budget speech. That was quite a boast for a Labour Chancellor to be able to make, and he did so in the context of a Budget which stressed the importance of "fairness" in taxation policy, of equipping the country for the future with "a modern taxation system based on principle".

Noble thoughts indeed. Unfortunately - and for some reason the Chancellor didn't mention this - they don't quite accord with the reality. As a direct result of his Budget measures, we are now faced with the prospect of one of the most unfair corporate taxation systems anywhere in Europe, one held together with bits of string and Sellotape, and one which in parts is so discriminatory that it might even fall foul of European law.

What's caused the problem is those wretched things, tax credits on dividends. By abolishing the credits but at the same time leaving the old connected system of advance corporation tax (ACT) in place, the Chancellor has created a whole raft of new anomalies in the tax system. Lasmo, the oil and gas company, has become the latest in a long line to write to the Chancellor warning of dire consequences if he doesn't do something to correct the position before it comes fully into force two years hence. In terms that admittedly seem just a little alarmist, Joe Darby, the chief executive, says the very independence of Lasmo and many other successful international British companies are put at risk by the proposals.

Actually this doesn't seem very likely in Lasmo's case, since the net effect of the measures would be to increase its tax bill by only pounds 2.5m a year. Some of the other predicted consequences, such as a mass exodus of companies to overseas domiciles, also seem exaggerated. The point is reasonably made all the same. British companies which don't earn much in the way of profits in the UK stand to get taxed twice, once on their earnings overseas, and a second time by way of advance corporation tax on dividends paid in the UK.

This is actually the situation that used to pertain before 1993, when Norman Lamont introduced his Foreign Income Dividends (Fids) scheme allowing companies that pay their dividends out of overseas earnings to reclaim the ACT. Now we are about to return to the bad old days.

It would be tempting to view this as just a soon-to-be-corrected oversight by the Treasury, as some executives do. Already the Government has made clear that the mirror system protecting overseas companies operating in Britain from ACT will be unaffected. Just as well, that, otherwise most of the City might have uprooted and moved to Frankfurt. But are we really now to have foreign companies better treated than British ones?

The truth of the matter is that the Chancellor has got his knickers in an awful twist over this. The reason is not hard to fathom; it is the usual one of revenue raising, for the abolition of Fids could be worth anything up to pounds 500m a year to the Treasury. To disentangle himself will therefore cost him dear. In the interests of fairness, however, he needs to address it. He's in danger of introducing an excessively complex, random and discriminatory system of corporation tax. It hardly accords with all those fine words.

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