Treasury makes U-turn on taxing foreign profits

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In an embarrassing U-turn, the Government has shelved plans to change the way the Treasury taxes the foreign dividends earned by subsidiaries of multinational companies based in Britain.

In a letter to the CBI, the Financial Secretary to the Treasury, Jane Kennedy, said: "The fiscal risks are too great to enable us to introduce a dividend exemption in next year's Finance Bill. I would welcome further discussion on the analysis of these costs. This will enable us to come to a better understanding of the associated fiscal risk and work towards a package that would enhance UK competitiveness and meet our objective of revenue neutrality."

The move was welcomed by the director general of the CBI, Richard Lambert, who replied to the Treasury stating: "This is a particularly important issue for internationally mobile businesses, many of which have increasing flexibility on where to locate. Much work is still needed but this needs to be pushed forward with the minimum of delay. Business still hopes that proposals can be included in the 2009 Finance Bill."

The Treasury wanted to simplify taxes on business and offered a deal whereby a crackdown on tax avoidance would be exchanged for an exemption on foreign profits.

But their plans raised concerns among executives and business leaders about the closure of these tax concessions and the differential impact on companies with substantial assets and activities outside the UK. The Government was also keen to prevent companies from shifting operations overseas, at least on paper, as a method of avoiding tax altogether.

Recently companies including the pharmaceuticals group Shire, the business information group United Business Media and Yahoo! have all said they will move to offices outside the UK for tax reasons. Ireland is one destination that many companies find attractive.

At the moment the UK taxes dividend earned abroad after discounting taxes collected locally. But that system yields little revenue while creating an administrative burden for companies, according to the Treasury.

But by eliminating the foreign dividend tax completely, companies would be technically able to shift revenue to lower-tax jurisdiction depriving the UK Government of revenue. That worry prompted the Treasury to examine its rules for the taxation of income earned by foreign subsidiaries.

The Treasury first proposed the changes in the March 2007 Budget and issued a consultative document in June that year.

The shadow Chancellor, George Osborne, said of Alistair Darling, the Chancellor: "We welcome the fact that he's ditched this disastrous policy, but even proposing the tax on foreign profits was deeply damaging to UK business."

Ms Kennedy added in her letter to Mr Lambert: "I would like to discuss our position with you and other representatives of business ... I expect this to form part of the agenda for the next meeting of the Business-Government Forum on Tax and Globalisation."