Introduction:

Advance Corporation Tax (ACT) was a mechanism used in the United Kingdom to collect corporate income tax from companies before the introduction of the imputation system. ACT was levied on dividends distributed to shareholders and served as a way to ensure that companies paid their taxes on profits before distributing dividends. The introduction of the imputation system in 1999 replaced ACT, making it a historical element of the UK's corporate tax landscape.

In this article, we explore the historical context and impact of Advance Corporation Tax on businesses during its existence.

1. Historical Context:

   ACT was introduced in the UK in 1973 as part of a broader tax reform. Before its implementation, companies were subject to corporation tax on their profits, but shareholders receiving dividends did not face any additional tax liabilities. This allowed for double taxation relief as the same profits were effectively taxed twice – at the corporate level and the shareholder level.

   To address this issue and prevent double taxation, ACT was introduced as a withholding tax on dividends. When a company distributed dividends to its shareholders, it was required to pay ACT to the government at a specified rate (often the same as the prevailing corporation tax rate). Shareholders could then offset the ACT they received against their own income tax liabilities, thus avoiding double taxation.

2. Impact on Businesses:

   The introduction of ACT had several implications for businesses:

   • Cash Flow Impact: ACT had a direct impact on a company's cash flow. Companies had to allocate funds to pay the tax on distributed dividends before they reached shareholders' pockets, potentially affecting available working capital.

   • Equity Valuation Considerations: The ACT regime influenced equity valuations, as investors factored in the tax credit that could be claimed on their personal tax returns when assessing the after-tax return on investments.

   • Incentive for Retained Earnings: Since ACT only applied to distributed dividends, companies had an incentive to retain earnings instead of paying them out to shareholders. This could affect dividend policy decisions and capital allocation strategies.

3. Imputation System and the End of ACT:

   In 1999, the UK replaced the ACT regime with the imputation system. The imputation system aimed to eliminate double taxation by allowing shareholders to receive tax credits for the corporation tax paid by the company on its profits. This system aligned the UK with other countries that followed the same principles of dividend taxation.

   Under the imputation system, companies provided a notional tax credit alongside their dividend payments, representing the corporation tax already paid on the profits from which the dividends were distributed. Shareholders would then use these tax credits to offset their own tax liabilities.

Conclusion: