Summary
Advance corporation tax (ACT) increased the tax cost to UK firms of distributing cash to shareholders. We demonstrate how the tax cost arising from ACT payments affected the channels through which UK firms returned capital to shareholders. In particular, we document and describe two unconventional irregular payout methods that enabled firms to avoid paying ACT. Firms choosing these methods are associated with significantly greater ACT problems than a control sample of firms that opted for conventional self-tender offers and special dividends. Event study tests indicate that the decision to adopt tax-efficient payout methods created significant additional value for shareholders beyond the basic cash distribution decision.
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Extract
Tax-Efficient Irregular Payout Methods: The Case of B Share Schemes and Capital Repayments Via a Court-Approved Scheme of Arrangement
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1. IntroductionThis paper exploits a unique historical feature of the UK tax system to investigate how corporation tax considerations influenced the channels through which firms returned capital to shareholders. Prior to 6 April 1999, UK firms paid their corporation tax in two instalments. The first instalment, known as advance corporation tax (ACT), was assessed according to the amount of income distributed to shareholders through dividends and share repurchases. The second instalment, mainstream corporation tax, was payable approximately nine months after the financial year-end, at which point firms could net-off ACT already paid. In principle, therefore, the burden of ACT simply represented a cash-flow-timing cost in the form of a partial prepayment of firms' corporation tax liability. However, the situation could arise where a firm was unable to recover all or part of its ACT prepayment. The resulting 'surplus ACT' represented an additional tax constraint that restricted corporate payouts to shareholders (Inland Revenue, 1997; Bond et al., 1996; Lasfer, 1996). Eventually the UK government bowed to pressure from the business community and scrapped ACT on 5 April 1999. The advance payment of corporation tax based on distributions to shareholders and the associated problems of surplus ACT are therefore no longer part of the prevailing UK corporate tax system.Prior research demonstrates a link between surplus ACT and payout choice in the context of regular dividend payments. Survey evidence reported by Lasfer (1997a) suggests that concern over surplus ACT was the driving force behind scrip dividends that gave shareholders the choice of receiving dividends in cash or shares. Scrip dividend alternatives to cash were attractive to firms with surplus ACT problems because, unlike cash payouts, share replacements were not subject to ACT. On the downside, however, the absence of any cash outflow meant that scrip dividends did not fulfil the same monitoring function as cash dividends (Easterbrook, 1984). Foreign income dividends (FIDs) were introduced in July 1994 as an additional way of relieving the surplus ACT burden facing UK-based multinationals.1 Essentially, FIDs allowed firms that paid dividends out of foreign earnings to opt out of the ACT system, thereby avoiding the costs of surplus ACT (Acker et al., 1997). Despite the potential corporate tax savings associated with scrip dividends and FIDs, neither metho...See the full content of this document
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