CTSA - taxflash no.3

Abolition of advance corporation tax - the shadow act regime

As a part of the reforms under Corporation Tax Self-Assessment (CTSA), Advance Corporation Tax (ACT) was abolished with effect from 6 April 1999. For large companies this somewhat cushions the cashflow impact of having to pay corporation tax earlier under the instalment regime (see CTSA TaxFlash No2). The Foreign Income Dividend system also ceased from 6 April 1999, as it is no longer relevant.

Abolition of ACT

Companies paying dividends on or after 6 April 1999 will no longer have to account for ACT. For distributions other than dividends there will also be no requirement to pay ACT. Submission of form CT61 is therefore not needed for dividends but it is still necessary for payments made under deduction of income tax, such as Gift Aid donations, royalty payments and certain payments of interest.

Despite there being no ACT, dividends still carry a tax credit in the hands of the recipient and dividend vouchers should therefore still show this credit. The tax credit is reduced from 6 April 1999 to be equal to one ninth of the dividend or 10% of the 'gross' distribution. It is non-repayable unless the shares are held in a PEP or ISA.

Surplus ACT

Prior to 6 April 1999 relief for ACT paid on dividends was given against a company's mainstream Corporation Tax liability, subject to a maximum offset based on the level of taxable profits. Where this maximum was exceeded the surplus ACT could be carried back or surrendered to a subsidiary company or if this was not possible, carried forward to the next accounting period.

With the abolition of ACT special rules have been introduced to restrict the offset of surplus ACT built up in periods before 6 April 1999, so that companies should broadly be able utilise their surplus ACT only to the same extent as previously. This is done through a system of shadow ACT.

Shadow ACT

The shadow ACT system will work as follows:

The existing maximum capacity to set off ACT of up to 20% of a company's corporation tax profits is retained.
This capacity for relieving ACT must first be used up by shadow ACT. Thus when a dividend is paid after 6 April 1999, the amount of ACT which would have been payable but for its abolition is calculated, taking into account any Franked Investment Income (FII) received, as before. This is the shadow ACT. The 20% capacity to set off ACT is reduced by the amount of shadow ACT, but with no actual reduction in the company's corporation tax liability.
Actual surplus ACT brought forward from an earlier year can then be set off but only to the extent that there is capacity not already used up by shadow ACT.
Surplus ACT still remaining can be carried forward until there is capacity to utilise it.
If dividends are paid at a level which generates surplus shadow ACT, this has to be carried back and can displace actual ACT relieved in the previous 12 months, leading to a further tax liability in the earlier period.

Groups

There are detailed and complex rules for groups of companies, to prevent shadow ACT in groups (ie a parent and it's 51% subsidiaries) being used in such as way as to obtain an advantage in using up actual surplus ACT brought forward.

For example:

No company in a group can set off any actual surplus ACT against its corporation tax until all of the group's shadow ACT has been set off.
A parent company cannot surrender all its shadow ACT, only that which remains surplus, after the maximum has been carried back.
With one exception intra-group distributions do not generate shadow ACT but also are not FII in the recipient company. Effectively, this is a mandatory group income election, which has the effect of generating shadow ACT at the top of a group. As surplus ACT brought forward is often also at the top of the group, it makes it more difficult to relieve this surplus.

Anti-Avoidance

There are also anti-avoidance rules to treat non-qualifying distributions, as well as dividends, as falling within the shadow ACT regime. This is to prevent avoidance by, for example, issuing loan notes instead of paying dividends and thus obtaining relief for past surplus ACT whilst still making distributions to shareholders.

Action Required

Despite the abolition of ACT itself, the new shadow ACT system means that careful planning is still required for the use of trading losses and actual surplus ACT and for the timing of dividends. Please contact the partner or manager who normally deals with your affairs.

Every effort has been made to ensure that the facts in this document are correct at the time of going to press. No responsibility for loss occasioned to any person acting or refraining from acting as a result of any material in this publication can be accepted. Authorised to carry on investment business by the Institute of Chartered Accountants in England & Wales.

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