Market-makers win fight over tax changes

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A concerted programme of lobbying by senior City figures is understood to have persuaded the Government to reconsider its plans to tax as trading profits the dividends received by market-makers. It is thought the main City firms have warned the Treasury that tax changes announced in the Budget might lead to market-makers moving their activities offshore.

According to one head of market-making, the Treasury is admitting privately that it misunderstood the implications of its proposed clampdown on tax avoidance in the City.

The measure was announced as an attempt to close a loophole that has long irritated the Inland Revenue and provided a useful stream of income for market-makers. The proposed change would end the tax exemption which share dealers used to enjoy on dividend income from the shares they held on their dealing book. Instead the dividends will be taxed as trading profits.

Previously a market-maker was able to receive a dividend tax-free while offsetting any fall in the capital value of the shares held against taxable profits. That created the possibility of buying a share just before it went ex-dividend and using the payment and the consequent fall in the value of the share as a means of minimising tax payments.

Although market-makers are understood to have been successful in persuading the Treasury they have been unfairly treated, a senior accountant yesterday expressed surprise that the Government would be swayed by their arguments. He said the changes actually levelled the tax system which had previously not treated market-makers' long and short positions in the same way.

UK banks have argued that the overall effect of the changes will be to put them at a competitive disadvantage compared with foreign competitors, which in some cases can deduct the tax levied on their UK trading profits from their own domestic tax bills under the provisions of double taxation treaties.

It is thought unlikely that UK banks would move their equity trading operations offshore, but the threat may have been enough for the Government to look again at changes which took the City by surprise.

The biggest impact of the proposed changes is likely to be in the complex area of derivative-backed contracts that investment banks have sold to insurance companies to back guaranteed bonds sold in the retail market.