Share valuations threatened by 'pounds 5bn tax increase'

The public finances are so fragile that an incoming Labour government will have to find up to pounds 5bn a year in extra corporate taxes, new research claims, undermining earnings growth forecasts and putting a lid on dividend payouts.

Domestic companies face a double hit as personal taxes are also pushed higher in an effort to raise a total pounds 10bn a year to reduce a bloated public sector borrowing requirement (PSBR).

As a result, BZW said this week, the stock market needs an unexpected interest rate surprise to justify its current level. Sectors at particular risk from a revenue-hungry new government include leisure, brewing and property, with oil companies and banks unlikely to escape the attentions of Gordon Brown for long.

According to Richard Kersley, equity strategist at BZW, the UK market remains fixated on the future direction of monetary policy after the election and has not yet taken seriously enough the threat of tax rises in both the consumer and corporate sectors.

He believes Labour, which has already signalled its intention to raise a windfall tax on the utilities, will turn its attention next to companies that, for a variety of reasons, currently pay less tax than the average.

Options for solving the revenue shortfall, which BZW believes will leave the public sector borrowing requirement at an uncomfortable pounds 30bn this year, include an increase to the corporation tax rate and more windfall taxes outside the utilities sector. More likely, given the policy priorities of a Labour government, is a widening of the tax base by closing loopholes or reducing allowances to put a squeeze on companies perceived to have had an easy ride.

The most widely discussed tax-raising option so far, an abolition or reduction of the tax credit on dividends, would be tempting for a Labour chancellor, but the issue is highly complex and BZW believes an early move on ACT is less likely than a more general review of the whole imputation system further down the line.

If taxes rise as BZW expects, the outlook for earnings growth will deteriorate considerably, from current 1998 estimates of about 10 per cent to as low as 7 per cent. Dividends are expected to grow at a similar rate, but the squeeze on cash flow from higher taxes could mean that forecast is too optimistic.

Companies highlighted by BZW as being especially exposed due to extremely low actual and forecast tax rates include Railtrack, hotel group Stakis and property developer Chelsfield as well as a host of utilities, including Anglian Water, Severn Trent and United Utilities.

Brewers, leisure companies and the property sector are all at risk, because capital allowances and the deductability of much of their repair, maintenance and refurbishment bills mean they pay very low taxes.

Greenalls, Vaux, Whitbread and BSkyB are all leisure companies that enjoy tax rates of under 25 per cent compared with the basic 33 per cent rate of corporate tax. Hammerson, Burford Slough Estates and MEPC are property companies that could be at risk from a Treasury looking to target low tax payers.

BZW believes the service sector could be the hardest hit, with firms' tax positions deteriorating at a time when their cost bases could be rising thanks to a minimum wage.