Vodafone Share News (VOD)

By Tom Bergin

LONDON, Dec 20 (Reuters) - When Neil Withington, the legaldirector of British American Tobacco (BAT) and the firm'slargest British shareholder, files his next tax return, he willreceive a little help from the state. Like every other UKtaxpayer, he will be entitled to a tax credit on any dividendpayment he receives. He can use it to reduce his total bill.

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

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

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

BAT is not exceptional.

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

Some tax experts say the system is no longer working asintended.

"The logic has fallen away now and the policy has becomesomewhat irrational," said Paul Morton, Head of Group Taxationat publisher Reed Elsevier.

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

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 As they do, and as headline UK companytax rates fall, is the UK dividend tax credit out of date?

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

"To give a tax credit where no tax has been paid doesn'tseem sensible ... The net effect on the public purse of thesearrangements needs to be reviewed," he said, adding that heplanned to write to the head of the Treasury Select Committee,the parliamentary scrutineer of the UK finances, to ask for aninvestigation of the credit system.

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

Brian Peart of the UK Shareholders' Association, whichrepresents individual investors, defended the credits, sayingthey helped encourage individuals to hold shares.

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

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 the1980s and 1990s, countries including Ireland, France and Germanyfound it too complex to match tax credits and corporate taxbills and scrapped tax credits on dividends altogether.

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

The dividend tax credit is not a cash sum, but an allowancethat individuals can use to reduce the income tax that would bedue on the dividend. It works out at one-ninth of the dividendpayment and is available to individual investors and thoseholding shares through funds.

The credit is not intended to fully compensate an investorfor their share of a corporate tax bill, a finance ministryspokeswoman said: The aim is "to reflect that some tax hasalready been paid on the profits rather than to mitigate 'doubletaxation' completely."

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

The government does not compile data on a company-by-companybasis, so it is impossible to see how many firms across thecountry are affected. Instead, Reuters examined accounts for 24firms that have appeared on a list of the biggest UK dividendpayers published annually by shareholder services group CapitaRegistrars. Of those, 16 disclosed data on their UK taxpayments.

Shareholders in 11 of them - from Anglo American Plc toVodafone Group Plc - received more in tax credits than they lostin corporation tax, Reuters found. The calculations were vettedby three tax experts. They said that a lack of clarity over whentax bills are paid creates some margin of error, but the overalltrend is clear.

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

Drinks group Diageo, which makes Johnnie Walker whisky andSmirnoff vodka, is another firm whose investors were netbeneficiaries of the tax credit system last year. In fact, overthe past 10 years, its total UK tax charge of around 330 millionpounds was just 3.7 percent of the 8.86 billion pounds it paidout 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 companiesthat Reuters examined. Those companies which responded said theyfollowed UK tax law and personal income tax rules were a matterfor the government.

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

"There was an expectation that shareholders would notreceive as credits more than the companies were paying in tax,so finding out there is a different outcome is unexpected," saidWales, now a partner with accountants PwC who was an adviser toChancellor Gordon Brown from 1997 to 2003.

"It seems the UK taxpayer is effectively subsidising theshareholders of these companies," he added.

WIDENING GAP

For the companies that Reuters studied, the switch is arecent phenomenon.

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

Tax advisers say the trend is explained by a drop of almostone-third in the corporate tax rate over the past six years, aswell as the fact UK dividends are increasingly paid from incomeearned outside Britain. Other - perfectly legal - tax avoidancetechniques may have helped.

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

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

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

Dividends paid out of profits earned, and taxed, overseas donot carry a credit.

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

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

BROAD APPEAL

Blue-chip investors may not have been the onlybeneficiaries.

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

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

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

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