Hard ACT for struggling firms

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ADVANCE Corporation Tax is the Government's way of forcing companies to act as tax collectors. It is an income tax on dividends, payable by the shareholders who receive them. But since the tax was introduced in 1983, it has been paid directly to the Inland Revenue by the companies paying the dividend.

Shareholders not liable to tax - including pension funds, charities and investors who hold shares through a personal equity plan - can reclaim the tax deducted at source from the Inland Revenue.

For these shareholders, the Budget changes mean a drop in income, because the tax credit available on dividends has been cut from 25 to 20 per cent. That means for every 10p of taxed dividends received, the amount taxpayers can reclaim has fallen from 3.3p to 2.5p. This is equivalent to a 6 per cent drop in dividend yields.

For companies, however, the effect of the changes is far more complicated. In theory, the only impact of a reduction in the ACT rate should be to improve a company's cash flow. As its name suggests, it is an advance payment of corporation tax and, as such, it is deducted from the main corporation tax liability due when the accounts are agreed with the Inland Revenue. The less paid when dividends are sent, the higher the final corporation tax bill.

In practice, the position is far more complicated. The first and most pressing problem for British companies at the moment is that ACT can only be offset against tax on profits generated in the UK. The prolonged recession means that many companies are struggling to make any profits and thus should not be liable to tax. But if they continue to pay dividends to shareholders, they still have to pay ACT.

Second, because the corporation tax rate - 33 per cent - is higher than the 25 per cent ACT rate, the set-off is restricted. The ACT cuts in the Budget - from 25 to 22.5 per cent for 1993/94 and 20 per cent thereafter - will cut it further.

The foreign income dividend proposed in the Budget is designed to help companies that make much of their profits overseas. Although ACT will have to be paid on dividends as now, it can be reclaimed if it can be shown that the dividend was paid for by foreign profits.