View from City Road: Buy-backs may be the best option

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The Independent Online
London Electricity yesterday became the eighth regional electricity company to buy back a large chunk of its shares, taking the total spent in this manner to well over pounds 1bn. Like a number of the others, the London Electricity buy-back was conducted in a way that might allow tax-exempt sellers, such as pension funds, to claim a substantial 'tax credit' from the Revenue on top of the sales proceeds. A great deal for pension funds, then, but perhaps not so good for the Exchequer. By all accounts, the Inland Revenue is hopping mad; it views the schemes as little more than tax scams, and is determined to clamp down on them in the next Budget.

Their history therefore bears some exploration. The first of the big buy- back schemes was launched by BAT Industries about five years ago and resulted in a quite heated and hitherto unpublicised behind-the-scenes City row. A clever tax-exempt seller in the buy-back spotted that the scheme was tantamount to a 'distribution' by the company to its shareholders, in the manner of a dividend payment. If that were the case, then tax-exempt funds were entitled to a tax credit on what the company had paid for their shares.

Unfortunately the scheme hadn't been set up in this way. The shareholder cried negligence and threatened to sue. Eventually the matter was settled out of court. To the embarrassment of BAT, it still had to pay advance corporation tax on the buyout payments as though they were a normal distribution. The Revenue's gain was the shareholders' loss.

When Reuters launched a buy-back a couple of years back, it deliberately set up the scheme in an off-market way so that there could be no quarrel with the Revenue about shareholders claiming the tax credit. Despite this, the early electricity buy-backs were conducted through the stock market in a manner which appeared to rule out any possibility of tax credits. Then came a new wheeze. So long as the market maker acts as agent for the company, rather than principal buying stock to sell on to the company, then the buyout might still be interpreted as a distribution and the tax credits clawed back.

If true, then the early buy-backs, some of which used the same securities houses as these present ones (Kleinwort Benson, Warburg, BZW), look to have been conducted in an imcompetent manner, rather like the case of BAT Industries, depriving shareholders of their right to reclaim tax which the companies will anyway have to pay the Exchequer.

Whatever the tax implications, the buy-backs plainly make good business sense. You can argue about the morality of handing over more than pounds 1bn of the country's collective electricity bill to already pampered investors, but that's a different issue.

The RECs plainly have no idea what to do with the torrents of cash they generate and the good times are not abating. Having been let off the hook by Professor Stephen Littlechild's lax price review, the companies' next windfall will be a share in the pounds 4bn to be raised from the sale of the National Grid.

Buying in shares may be unimaginative. It may also underline the limitations of the industry's lacklustre management. But it beats pouring the cash into ill-conceived diversifications and, perhaps more important, it beats storing up the money only to have a future government throw a one-off tax at the industry to confirm its populist credentials.

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