The Budget: Twin attack on the burden for companies: Advance Corporation Tax

ADVANCE Corporation Tax was dismissed by the Chancellor as an area that only a 'select few' were familiar with, but the changes are among the most significant, for companies and their shareholders, of any in the Budget.

In a two-pronged attack on the ACT burden, which has pushed tax rates for some companies over 100 per cent, the rate of the tax is to be cut and companies will be allowed to reclaim surpluses if dividends have been paid out of profits overseas.

The Chancellor also made it clear that he will not allow ACT to deter foreign investors from setting up operations in Britain, with the promise of a new tax regime to be introduced next year to make Britain more attractive to international investors.

The changes were welcomed by businessmen as evidence that the Government has been listening to the storm of protest about the tax.

Roger Woods, who heads the ACT working party of the 100 Group of finance directors of leading companies, said: 'The Chancellor has shown he has taken the matter seriously.

ACT is deducted from dividends before they are paid to shareholders, and can be offset against companies' mainstream corporation tax bills. But it can only be set against tax on profits earned in Britain. The recession, coupled with overseas expansion by many companies, means that British tax bills are often too low for ACT to be fully reclaimed.

Under the proposals announced yesterday, the rate of ACT will be cut from 25 per cent to 22.5 per cent from 6 April, and to 20 per cent the year after. A consultative document was also issued on a change to the rules which would allow companies to elect to pay a foreign income dividend. ACT will be paid on this in the normal way but can be reclaimed if the dividend was paid out of overseas profits.

Surplus ACT afflicts companies as diverse as BAT, the tobacco group, and Lucas Industries, the engineer. The action seems to have been prompted by fears that it discourages companies from investing in Britain, encouraging them to move activities in areas like research and development overseas.

In effect an interest-free loan from British industry to the Treasury, surplus ACT has reached pounds 5bn and is growing at just under pounds 1bn a year. The rate reduction is expected to cut the surplus by about pounds 300m a year, and will increase companies' cash-flow by pounds 2bn in the next two years.

Andrew Robb, finance director of Pilkington - which suffered a tax rate of 97 per cent in the six months to September - gave the changes a 'cautious welcome. It has implications for our shareholders' income, but it does increase our flexibility.'

There will, however, be penalties for shareholders. Under the current system, shareholders who do not pay tax - such as pension funds - can reclaim tax on their dividends at 25 per cent. This will now be cut to 20 per cent, and they will not be able to reclaim tax on foreign income dividends when they are introduced.

But Mr Woods believes the changes could mean higher dividends. 'What he is doing is saving companies' cash. The more they have, the more they will invest and create profit.'

The Government's eagerness to attract overseas investment, against competition from countries such as Belgium and the Netherlands, where the tax regime is favourable, is underlined by the fact that these changes will be introduced regardless of the outcome of consultations on proposals for British companies.

But Richard Collier-Keywood, tax partner at Coopers & Lybrand, said: 'The reduction in the rate of tax credit will have an adverse impact on non-resident shareholders investing from countries like the US, as the value of the dividend paid will fall by 4 per cent.'