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Insight: The Great British tax giveaway

The sun rises above the financial district of the City of London in this April 23, 2011 file photo. REUTERS/Kieran Doherty/Files
The sun rises above the financial district of the City of London in this April 23, 2011 file photo. REUTERS/Kieran Doherty/Files

By Tom Bergin

LONDON (Reuters) - When Neil Withington, the legal director of British American Tobacco (BAT) and the firm's largest British shareholder, files his next tax return, he will receive a little help from the state. Like every other UK taxpayer, he will be entitled to a tax credit on any dividend payment he receives. He can use it to reduce his total bill.

The credit is intended to compensate shareholders for the fact that dividends are paid out of income which has already been subject to UK corporate income tax. To help avoid the same money being taxed twice, the UK trims its levy on dividends.

There's just one problem: BAT, Europe's biggest cigarette maker by sales, didn't have a UK tax bill at all last year. In fact, its accounts show, over the past six years its total UK tax expense has been zero.

This means that the company's investors are being given credit for taxes the firm has not actually paid.

BAT is not exceptional.

A Reuters examination of available public records has found that for the most recent financial year, British shareholders of at least 11 major blue chip firms have received more in dividend tax credits from the UK tax authority than they lost through the corporate income tax levied on their companies. This means that in effect, the UK government is subsidizing them to own shares.

Some tax experts say the system is no longer working as intended.

"The logic has fallen away now and the policy has become somewhat irrational," said Paul Morton, Head of Group Taxation at publisher Reed Elsevier.

A spokesman for BAT said it, and members of staff who own shares in the group, pay taxes in accordance with UK law which is "set by the HM Treasury and Parliament." He added that this reflected Withington's view. Withington declined to comment.

BAT's low tax bill also reflects the fact that less than 1 percent of its turnover is generated in Britain, company accounts show. Other companies, too, are making more of their money in global markets. As they do, and as headline UK company tax rates fall, is the UK dividend tax credit out of date?

John Hemming, a member of parliament with the Liberal Democrats, the junior member of the UK coalition government, said in response to Reuters' findings that it was time for the government to rethink the whole system.

"To give a tax credit where no tax has been paid doesn't seem sensible ... The net effect on the public purse of these arrangements needs to be reviewed," he said, adding that he planned to write to the head of the Treasury Select Committee, the parliamentary scrutineer of the UK finances, to ask for an investigation of the credit system.

The government gives taxpayers dividend tax credits worth around 4 billion pounds ($6.56 billion) each year, a Freedom of Information request made by Reuters reveals. That sum has risen around five times faster than the tax take from corporations over the past decade. Overall, the UK still collects much more in corporate income tax - an average of 33 billion pounds per year over the past five years - than it gives away in tax credits on dividends.

Brian Peart of the UK Shareholders' Association, which represents individual investors, defended the credits, saying they helped encourage individuals to hold shares.

"There are not enough private shareholders," he said. "If it was abolished, this would make it worse."

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Graphic: http://link.reuters.com/dyt55v

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MORE GENEROUS THAN INTENDED

The UK system dates back to 1973, and today it's unusual. As corporate income tax rates fell around the globe through the 1980s and 1990s, countries including Ireland, France and Germany found it too complex to match tax credits and corporate tax bills and scrapped tax credits on dividends altogether.

The United States has never given dividend tax credits, said University of Connecticut School of Law Professor Richard Pomp.

The dividend tax credit is not a cash sum, but an allowance that individuals can use to reduce the income tax that would be due on the dividend. It works out at one-ninth of the dividend payment and is available to individual investors and those holding shares through funds.

The credit is not intended to fully compensate an investor for their share of a corporate tax bill, a finance ministry spokeswoman said: The aim is "to reflect that some tax has already been paid on the profits rather than to mitigate ‘double taxation' completely."

However, in cases like BAT, the system does more than this. Indeed it means investors in many firms that pay big dividends are, like Withington, saving more in dividend tax credits than they lost through their share of the companies' corporate tax bill.

The government does not compile data on a company-by-company basis, so it is impossible to see how many firms across the country are affected. Instead, Reuters examined accounts for 24 firms that have appeared on a list of the biggest UK dividend payers published annually by shareholder services group Capita Registrars. Of those, 16 disclosed data on their UK tax payments.

Shareholders in 11 of them - from Anglo American Plc to Vodafone Group Plc - received more in tax credits than they lost in corporation tax, Reuters found. The calculations were vetted by three tax experts. They said that a lack of clarity over when tax bills are paid creates some margin of error, but the overall trend is clear.

In practice, tax experts say that the tax credit starts to become more generous than it was meant to be as soon as the corporate income tax bill falls below 10 percent of its dividend payments.

Drinks group Diageo, which makes Johnnie Walker whisky and Smirnoff vodka, is another firm whose investors were net beneficiaries of the tax credit system last year. In fact, over the past 10 years, its total UK tax charge of around 330 million pounds was just 3.7 percent of the 8.86 billion pounds it paid out in dividends.

Diageo declined to comment on its UK tax bill.

Most of the company's profits are made outside Britain. Diageo's experience is replicated at most of the 16 companies that Reuters examined. Those companies which responded said they followed UK tax law and personal income tax rules were a matter for the government.

It wasn't meant to be this way, said Chris Wales, who was chief tax adviser to the UK's finance minister in 1997 when the dividend tax credit system was last overhauled.

"There was an expectation that shareholders would not receive as credits more than the companies were paying in tax, so finding out there is a different outcome is unexpected," said Wales, now a partner with accountants PwC who was an adviser to Chancellor Gordon Brown from 1997 to 2003.

"It seems the UK taxpayer is effectively subsidizing the shareholders of these companies," he added.

WIDENING GAP

For the companies that Reuters studied, the switch is a recent phenomenon.

Ten years ago, the cost of investors' tax credits was around half the corporate tax burden borne by investors in those companies. Things began to change around 2007.

Tax advisers say the trend is explained by a drop of almost one-third in the corporate tax rate over the past six years, as well as the fact UK dividends are increasingly paid from income earned outside Britain. Other - perfectly legal - tax avoidance techniques may have helped.

The finance ministry spokeswoman said it would be too complex to align the tax payments of individual companies with the credits their shareholders received.

"It would ... be almost impossible in legislative, computational, not to mention administrative, terms to link the level of tax credit due on specific distributed profits to the amount of tax that has been paid on it," she said.

However, Australia and New Zealand, two of a small number of countries which still give investors dividend tax credits, operate such a system. These countries give credits only in respect of that portion of a dividend which has faced domestic taxation.

Dividends paid out of profits earned, and taxed, overseas do not carry a credit.

Until the 1997 overhaul, Britain also operated a system which ensured investors could not receive more in credits than their share of the overall tax bill. This was scrapped in 1999.

Overall, the volume of tax credits awarded jumped 120 percent between 2001-02 and 2010-11, according to HMRC data. That compares with a 20 percent rise in total corporation tax payments.

BROAD APPEAL

Blue-chip investors may not have been the only beneficiaries.

The rise in claims for tax credits may in part be linked to tax management by self-employed individuals, said Kevin Thorne, tax partner at Grant Thornton in London. Britain's tax authority agrees that over the past decade, many individuals began to arrange their affairs through companies, partly because paying themselves in dividends could reduce their tax bills.

And shareholders in companies outside the UK also get the tax credit. Britain is the only country which 10 tax experts Reuters interviewed could name that gives its taxpayers credits on dividends they receive from foreign firms.

That's the result of rulings in the European Court of Justice in the mid 2000s. Under European Union law, the court found, if you give a tax break on dividends from UK companies, you must do the same for investments in foreign firms. The finance ministry declined to provide figures for how much the extension cost.

"It was never a principle of UK policy that the government would do that but it became inevitable because of EU treaties," said Wales.

($1 = 0.6101 British pounds)

(Edited by Sara Ledwith and Will Waterman)

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