Treasury to consider new tax plans for pension funds

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THE Treasury has been looking at whether to further increase the tax burden on pension funds, and use the money to cut corporation tax on companies.

The move is understood to be one of the Budget options considered during research into the impact of high dividend payouts.

There has been concern that high dividends could be one of the reasons for low investment in Britain, an issue that has been under scrutiny as part of a review of savings conducted by Stephen Dorrell, the Financial Secretary.

The Prime Minister has publicly ruled out a direct attack on dividends. But the City believes the likeliest move is an indirect one, through taxation.

Last year's spring budget brought in pounds 1bn a year in extra revenue by cutting the rebate paid to pension funds on their dividend income. Pension funds are tax-exempt and the rebate is a repayment of advance corporation tax (ACT).

This provoked a furious reaction from pension funds, which said that the lost revenue would force companies to pay more into their pension schemes.

The new option is designed to counter critics of a fresh move against pension funds. It would offset the gain from a further reduction in the ACT rebate.

This would be presented not as a way of raising new money but as an attempt to put right imbalances between the taxation of dividends, debt and company profits.

Tax-exempt pension funds are Britain's biggest investors, so the overall tax paid to the exchequer on company dividends is modest.

Critics claim this low tax regime encourages high dividend payments, and that companies would invest more if they kept back a larger part of their profits.

Pension funds and other institutional investors deny this and have been mounting a campaign against further changes to the rebate.

One senior source said yesterday that he believed the Treasury had already been persuaded by the City to shelve the option of a cut in both the corporation tax and rebate rates, at least for this year's Budget.

City lobbyists are convinced the Treasury is still taking the dividend issue seriously. But they say the Treasury is coming to appreciate the complexity of the links between dividends, pensions and corporation tax issues.

Fund managers have said that even if the Treasury manages to make the change tax neutral for companies and ignores the protests of pension funds, it would damage the campaign to increase the take-up of personal pensions.

Monthly contributions would have to rise to maintain the same level of benefits.

The National Association of Pension Funds believes claims about excessive British dividends are misconceived because the growth in recent years has been due to high payments by former nationalised industries entering the private sector.