Treasury investigates dividends rise: Dorrell tells of concern about companies' payout ratios increasing sharply during the recession

THE Treasury is investigating the sharp rise in dividends in the 1980s, particularly during the recession.

It is especially concerned by the reluctance of companies to adjust payouts when profits fall in a recession.

Stephen Dorrell, Financial Secretary to the Treasury, has also confirmed that he is examining whether the balance between tax paid on dividends and on bond interest is right.

In an interview with the Independent he also urged the City to devise new and more flexible forms of loan for small- and medium-sized business, with a payback geared partly to company profits.

But Mr Dorrell's review of savings and the flow of finance to industry has prompted fears among City institutions of a fresh assault on tax paid by pension funds and insurance companies, including further changes in advance corporation tax.

Mr Dorrell said he had not come to any conclusions and he promised more public discussion before the Treasury came to any tax decisions.

But he has taken the dividend inquiry further since a speech to the CBI last month, when he posed the question of whether it was right to have a much higher level of dividends in the UK than in Germany and Japan.

His main concern now is the speed of increase in dividends and their inflexibility.

He said that he was not focusing on the different payout ratios here and in Germany, for which there were a number of explanations, but on the fact that payout ratios in the UK had risen quite sharply in the 1980s, particularly in the recession.

'Does that mean that dividends are no longer as flexible in relation to pre- and after-tax profits as they used to be? If it is true that they have become less flexible that is an economic development of some significance,' Mr Dorrell said.

Some institutions, such as M&G, the unit trust group, have campaigned to persuade companies not to cut dividends. But critics of such policies argue they undermine investment.

Mr Dorrell said: 'The one thing we can't and won't do is tell companies or investors what is the appropriate level of dividend. What we can do is ask why is it that dividends have become less flexible and ask what the consequences are. If it is true, you can't simply gloss over it.'

He said it was not necessarily a good or bad thing if dividends were less flexible than 10 years ago but if true, it was a fact of considerable significance, even for the FT-SE 100 companies.

The Treasury, he said, had prima-facie evidence that officials were working on, but he would not act without throwing it open to further public discussion.

Mr Dorrell also said the Treasury's agenda included an examination of the unfavourable tax treatment of dividends compared with interest.

He gave as an example a private investor paying a 40 per cent marginal income tax rate.

With undistributed corporation tax the total tax on the dividend paid out could be as high as 53 per cent.

But if a company paid the same proportion of its profit as interest on a bond held by a pension fund no tax would be paid.

Mr Dorrell said that the ordinary shareholder was the one that carried the higher risk. 'That disparity is not obviously rational.'

This was a question of tax policy to which there was no obvious answer, but the way the tax system impinged on the capital markets was very much part of the review, Mr Dorrell said.

He did not want to be drawn on the conclusions. The review was 'very much focused on asking the question of whether the policy levers available to us should be moved'.

He said the Treasury was 'thinking about' a suggestion from the Commons Trade and Industry Committee that there should be tax changes to encourage the use of scrip dividends.

Mr Dorrell also urged the City to find new ways of backing companies, including developing concepts such as mezzanine finance for use by small- and medium-sized companies.

This is a form of loan where returns are geared to profits and they have been mainly used for management buyouts and buy-ins.

Mr Dorrell said Britain had too limited a range of financing options for industry compared with some other countries.

(Photograph omitted)