Green Budget: Corporate taxes - Business fears pounds 8bn hit from phas ed abolition of ACT

Business estimated last night that it would be billions of pounds worse off as a result of the reforms of the corporation tax regime proposed by the Chancellor. The benefit to the Treasury is forecast to be about pounds 7.5bn over the four years following 1999, the year when the measures are intended to be introduced.

While the decision to abolish advance corporation tax (ACT) was last night broadly welcomed by companies and their advisers, they claimed that the planned introduction of quarterly tax payments would have a huge effect on cashflow. There was also concern about the confusion and complexity that might result from the transition arrangements.

One particular cause of worry was allayed by the revelation in documents released by the Inland Revenue (IR) after Gordon Brown had sat down that individual taxpayers would not incur any loss additional to that suffered as a result of the ending of the dividend tax credit announced in the July Budget. This is because the tax credit will be retained, despite the abolition of ACT.

But accountants are concerned that it might also prevent British-based multinationals, such as BAT and ICI, from using up the great ACT surpluses that they have accumulated as a result of their strong earnings overseas.

The move against ACT - which had been widely predicted in the wake of the Budget's ending of the tax credit on dividends - had been expected to benefit multinationals at the expense of other companies, such as retailers and banks which receive most of their earnings in the domestic market. But advisers are now unsure about who will benefit most - though water companies, which had been able to offset much of their tax liability through their heavy investment programmes, are predicted to emerge as clear winners.

Paul Wopshott, tax partner with accountants Price Waterhouse, said: "Although from April 1999 their ACT surplus will no longer get bigger because of the abolition of ACT, they will find it no more or less easy to get at their past surplus because of the introduction of `shadow' ACT - a system whereby companies will have to pretend to account for ACT whenever they pay a dividend."

He added: "Under present rules, the amount of past surplus ACT which can be set against a corporation tax liability is limited by current year ACT which has to be used first. The Government is to replace this rule with a limitation by reference to current year `shadow' ACT, leaving the company's historic position unchanged. Some major corporates will probably still find it impossible to make a dent in their ACT mountain for the foreseeable future."

He and counterparts elsewhere are predicting that companies will use "the window of opportunity" created by the announcement of the end of ACT to return funds to shareholders through extra-large foreign income dividends, a technique that Mr Brown has already pledged to end.

City observers believe that the removal of ACT is likely to lead to a wave of share buy-backs among companies that have previously been deterred from making such a move as they would have faced higher tax bills.

Philip Isherwood, equity strategist at Merrill Lynch, predicted that companies were likely to buy back up to 5 per cent of the stock market by 1999, which would have the effect of increasing corporate earnings by 1.5 per cent. Mr Isherwood also predicts that the reduction in the corporation tax on companies will increase earnings by 2 per cent. He said: "This is good news for equities, although we will have to wait for some time for the benefits."

Mark Tinker, equity strategist at UBS, agreed that the removal of ACT would mean more share buy backs, especially among the utility groups. However, he pointed out that the Chancellor's statement did not tell the whole story. Mr Tinker said: "This has whetted appetites rather than satisfied them. We don't know about capital gains tax and the tax treatment of dividends. This is only one piece in the jigsaw." ACT and tax credits on dividends were a by-product of the imputation system introduced in Britain in 1973 in an effort to reduce double taxation. ACT was triggered when a corporation paid a dividend. The company would pay shareholders a dividend net of the starting rate of income tax and would pay the tax direct to the IR where it would count as a payment in advance of part of the company's tax bill.

In proposing a system of quarterly instalments, the Government is attempting to move the United Kingdom closer to the practice in such countries as the United States. It is proposed that this be linked with the introduction of self-assessment so that companies will face having to base their payments on their expected tax liability for the current year rather than their past year. Advisers expect companies to challenge this in the consultation period on the grounds that it will put too much of an administrative burden on them.

The IR is proposing that the instalment system be introduced over four years, accounting for 60 per cent of tax liability in the first year, 72 per cent in the second, 88 per cent in the third and 100 per cent in the fourth. For medium-sized companies - those with pre-tax profits of between pounds 330,000 and pounds 1.5m - the figures will be half these, while small companies - those earning less than pounds 330,000 - will be exempt.

Business was more enthusiastic about other aspects to the changes to the corporate tax regime. The plan to reduce the rate from 31 per cent, already an all-time UK low, to 30 per cent from April 1999 was obviously welcomed, while the promise of changes to capital gains tax in the next Budget was seen as a balance to the attack on investment caused by the ending of tax credits. Lawrence Green of the solicitors Eversheds said it would boost long-term investment.

Although Mr Brown followed the example of other chancellors in stressing how serious he was about combating tax avoidance, details issued by the IR suggest that the lobbying against a general anti-avoidance regime has been successful, and specific areas of abuse will be targeted instead.

Financial directors responding to a recent survey generally supported further investigations of tax-avoidance schemes, but advisers warned that such a piecemeal approach could lead to the introduction of flawed legislation which would increase uncertainty at a time when the Government was said to be keen to make taxation of companies simpler and fairer.