The 'Tax Simplifier' series aims to make the case for a much simpler tax code with practical recommendations for policy change. Blogs are published twice a week, on Monday and Thursday. Read David's previous blog on remforming the annual budget. You can follow David on Twitter @TaxSimplifier.
There is one, perhaps unexpected, defendant that stands accused of artificial tax manipulation. The scheme enabled it to avoid making payments of tax. HM Government, please step into the dock!
The story concerns dividend tax credits. In 1997 Gordon Brown made the notorious decision to abolish the repayment of dividend tax credits to pension funds. This had an enormous impact on the pensions industry, in particular on their ability to maintain final salary pension schemes. It was also a reason (although not the only reason) for the dramatic drop in equity investment by the pensions industry in recent years.
At the same time it was announced that repayable dividend tax credits would be phased out for charities and the like.
But then what was the point in 1999 of a further announcement that the dividend tax credit would be reduced to 10% of the gross amount, but that the tax rates on dividends would be reduced so the net liability of individual shareholders would be unchanged ?
By reason of this complication basic rate taxpayers, 40% taxpayers and 45% taxpayers all have separate dividend tax rates This would not have been necessary if the dividend tax credit had been maintained at 20%.
There seems to be only one answer. The change was made to reduce or often eliminate the amount of the dividend tax credit repaid to overseas shareholders under Double Tax Treaties.
Now if a foreign Government enters into a Double Tax Treaty with the UK it does so on the basis that tax concessions are made by both sides in order to avoid double tax. Usually foreign countries levy withholding tax on dividends, and tax treaties provide for this to be reduced when dividends are paid to UK residents. The quid pro quo, when the treaties were negotiated, was that foreign resident shareholders in UK companies would be repaid part of the tax credit on UK dividends.
The foreign Government would not have expected that the UK government would reduce the UK tax credit to deny this entitlement - whilst retaining the Treaty benefits for UK shareholders of reduced foreign withholding tax on foreign dividends!
If there was no other reason for reducing the dividend tax credit credit this was shoddy behaviour by our Government.
And it over-complicated our domestic tax law as well!
I have previously proposed that UK dividends should be tax deductible and be paid subject to withholding tax. (If this were done most treaties would, as currently drafted, automatically give the right to a reduced rate of withholding for overseas shareholders). But until this is done we should simply restore the dividend tax credit to 20%.