Advance corporation tax

In the United Kingdom, the Advance corporation tax (ACT) was the scheme under which companies made an advance payment of tax when they distributed dividend payments to shareholders. The principle is similar to the way that interest earned on bank deposits in the UK normally has basic rate tax deducted by the bank before being paid to the account holder.

In general this payment meant that the recipients of the dividend were considered to have already paid basic rate tax on their dividend income. Certain recipients, including pension funds, who would not otherwise have paid income tax on the dividend income were entitled to claim back this (or later a lesser) amount from the treasury.

The amount of ACT paid by a company could also be offset against the company's profits reducing its final corporation tax bill.

History

ACT was introduced in 1973 at a rate of 30% (the basic rate of income tax at that time). Until 1993 the income tax rate payable on dividends was the same as any other income. From 1973 until 1993 the ACT rate was adjusted to keep it the same as the basic rate of income tax. In 1993 the ACT rate was cut to 22.5%. At the same time the rate of income tax payable on dividends (20%) was for the first time set at a different rate to that payable on other income (25%). The tax relief payable was tied to the 20% rate rather than the ACT rate meaning that non-taxpayers could no longer reclaim the full amount that had previously been taken by the exchequer as ACT.

In 1997 the tax relief for non-taxpayers (except charities and PEPs) was scrapped completely. This had a particular impact on pension funds which were no longer able to reclaim any of the money taxed as ACT from their dividend income. More fully, it was a technical change in the way corporation tax is collected the indirect effect of which was for the dividends on equity investments held within pensions to be taxed, thus lowering pension returns and allegedly contributing to the demise of some pension funds. The Treasury contend that this tax change was crucial to long-term economic growth: the existing corporation tax system created biased incentives for corporations to pay out profits as dividends to shareholders (including pension funds, who could then reclaim the tax paid) rather than to reinvest them into company growth (which would result in corporation tax being paid). The old system of corporation tax was widely viewed by economists as a constraint on British economic growth. ^[1]

The Times uncovered documents under the Freedom of Information Act in April 2007 that showed the chancellor Gordon Brown had been advised that pension funds would suffer a £67 billion loss of the actuarial value of their assets as a net result of a combination of policies including the ACT change.^[2]

ACT was scrapped by Gordon Brown, effective from 6 April 1999.^[3] but 10% tax relief on dividend income continued.

References