Tax credit fears hit share prices

Fears the Government will use next month's Budget to abolish the tax credit pension funds receive on dividend payments hit share prices yesterday, toppling them from the new peak set at the end of last week. The FTSE 100 index ended 38 points lower at 4,745.1, the first fall in three trading days.

The setback was triggered by a report, described as speculation by the Treasury, that the Chancellor, Gordon Brown, plans to raise up to pounds 5bn by abolishing the 20 per cent tax credit tax-exempt institutions such as pension funds can claim against company payments of advance corporation tax. Critics of the tax scheme have blamed it for the relatively high dividend payments made by UK businesses.

Although pension funds have been the most vociferous in lobbying against plans to scrap the tax credit, business organisations say it would hit their cash flow too. Ian Peters, deputy director general of the British Chambers of Commerce, said yesterday: "There is a danger it will have an adverse effect on businesses because they could be forced to make up the shortfall in pension fund income."

In its Green Budget last month, the independent Institute for Fiscal Studies agreed with this analysis and said any money raised by scrapping the tax credit should be returned to the company sector. It said this would be a clear test of the Government's commitment to raising the level of business investment.

The Institute of Directors yesterday warned hefty rises in corporate taxes in next month's budget would "seriously undermine" the Labour Party's new-found support from the business community. Tim Melville-Ross, director general of the IOD, said the leaks from the Treasury suggesting the tax changes risked turning City sentiment against the Government.

"We are far from saying that the government has proved its credentials in terms of being business friendly. The last building block in the short term is the Budget and a swinging increase in corporate taxation would seriously undermine the developing relations between the business community and the new government," he said.

However, earlier estimates that abolishing ACT credits would hit the market by as much as 10 per cent were played down by many observers yesterday. The pounds 5bn that the move would raise for the Government was itself comfortably exceeded by yesterday's fall in the value of the market, which Datastream put at pounds 8.66bn. In the context of a market still valued last night at pounds 1,193bn, pounds 5bn would be a drop in the ocean.

Analysts said there would have to be a modest downward correction to restore the relative yields on equities versus Government securities or gilts.

Separately yesterday Railtrack denied it had been told it would pay the windfall tax. A spokeswoman said the privatised rail group had not held any discussions with the Treasury.