Hundreds of the country's largest pension funds "underwrite" the equity issues made by companies when they want to raise extra funds, according to the National Association of Pension Funds (NAPF).
If such activity is made liable to tax it could deter pension funds from underwriting, which in effect acts as a guarantee to the firm that its share issue will be sold.
Uncertainty has arisen about the tax status of pension funds because the Inland Revenue has started to assess some of them on the basis that their underwriting activities are equivalent to trading, and therefore subject to tax. Pension funds are exempt from tax on investment income, but not from income on trading activities.
Railpen is taking its case to the Birmingham Tax Commissioners early in the new year in an attempt to resolve the issue, which has been rumbling on for the last 10 years or so.
"The government has exempted pension funds from taxation and has always wanted them to help British business raise capital for new investment," Malcolm Gray, finance director of the Railpen trustees, said yesterday.
"Now, Inland Revenue officials are using threats and inducements to coerce funds to sign agreements to pay tax which may not be refundable even if a court subsequently confirmed that tax is indeed not payable," Mr Gray added.
Keith Wallace, partner at Richards Bulter, Railpen's solicitor, said the pounds 22m tax bill from the Inland Revenue for the tax years between 1981 and 1996 had over-estimated the fees generated by Railpen in the same period which were pounds 9m. The Inland Revenue typically over-states tax claims.
The Inland Revenue yesterday rejected allegations that it had used threatening tactics. A spokeswoman said that the law on this matter, set out in 1971, laid down that pension funds could be liable to tax on underwriting engaged in on a "regular" basis.
But the NAPF argues that the original intention of the government in 1971 was to make underwriting commissions exempt from tax.
"Despite the express statutory exemption, individual tax inspectors have sought to bypass the exclusion by asserting that the activity of underwriting constitutes a taxable `trade'," NAPF wrote in its submission to Kenneth Clarke, the Chancellor, ahead of the Budget.
"The Revenue has raised a number of large tax assessments on pension funds for underwriting commissions. These remain unresolved ... and do nothing to relieve the climate of uncertainty," the NAPF said. The pension fund body wants the Chancellor to clarify that underwriting is not a trading activity when undertaken by approved pension funds and is therefore exempt from tax.
"Enabling British companies to raise [equity capital], irrespective of current economic circumstances, directly facilitates the smooth operation of the financial markets."
"The Inland Revenue concentrates on detailed wording which was not written against the background of today's operational environment," it added.
The Inland Revenue is understood to have made tax claims against 12 of the country's biggest pension funds and one of has settled its bill.
Even after last year's Budget, the NAPF was writing to the Chancellor to complain about the position. "I have indicated the danger to the Chancellor that as the result of the activities by the Inland Revenue, there is a real concern that pension funds will decide to withdraw from sub-underwriting."
"The overwhelming majority of pension funds which have acted as underwriters have done so on a bona fide basis in the belief that the marginal returns they obtained enable British industry to raise equity capital."Reuse content