Brown urged to consider foreign dividend tax reform

The chancellor is under pressure to float radical reforms to the taxation of foreign dividends in the pre-Budget report on Wednesday.

Multinationals are awaiting a formal consultation on scrapping the 200-year-old system of taxing worldwide income, in the wake of several months of behind-the-scenes discussions at the Treasury.

The drive to reform the system is a result of concerns about the international competitiveness of the British tax regime and high-profile European court challenges.

Businesses are also anxiously awaiting the outcome of the recent consultation on Revenue & Customs’ penalties and powers, which is expected in the pre-Budget report.

It is likely to usher in a new regime imposing stiffer penalties on businesses that do not comply with tax rules.

Gordon Brown is also under pressure to unveil corporate tax cuts. Chris Sanger, head of tax policy at Ernst & Young, professional services group and a former Treasury adviser, said Mr Brown might set an aspirational goal of cutting the tax rate by several percentage points over five years.

One of the main options that would be considered in a consultation on foreign dividends is the adoption of a “territorial” tax system, such as that used in the Netherlands, which exempts profits earned overseas from tax.

But companies are strongly opposed to the prospect of new restrictions on their ability to deduct interest costs from their tax bills, which they fear would accompany the proposals. Such a move would be highly controversial as, under European law, it would have to apply to domestic companies as well as multinationals.

The restrictions on interest would be an attempt by the Treasury to reduce the tax risks posed by a switch to a territorial system.

It fears that companies could reduce their tax bills by borrowing money to invest overseas, without the prospect of paying tax on the overseas earnings.

The Institute of Directors called for a “clear statement of intent” on where the corporate tax system was heading.

It urged the government to replace the current system of taxing foreign dividends with a blanket exemption for dividend income.

“As well as reducing an often pointless administrative burden, this would enhance the appeal of the UK as a location for group holding companies,” it said.

It warned the government against clamping down on rules for deducting interest costs from tax.

“Any change would be enormously disruptive. It would take away one of the biggest plus points of the UK’s system and make the UK much less appealing to foreign investors than it is at the moment.”

Many large British companies resent the Treasury’s insistence on taxing overseas profits, since their overseas operations are increasingly likely to exceed their British operations.

Even though credits for taxes paid overseas mean that the government’s total tax take from overseas earnings is only about £700m, the rules governing foreign earnings are complex and burdensome.

Complaints about the existing system have come to a head as a result of a European court ruling on a case brought by Cadbury Schweppes in September that said the UK’s “controlled foreign company” rules – which allow it to tax profits earned in low-tax countries – should be limited to wholly artificial tax planning.

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