U.K. taxation: a quiet revolution.

• Author: Dent, Christopher H.

One of the most striking features of the last two decades has been the genuine globalization of business. Multinational corporations have been around longer, but it is only in the last 20 years that the worldwide shift towards a more open economic philosophy, partly through the influence of bodies such as the European Union (EU), has permitted multinationals to plan their activities on a global basis. One of the more surprising (and indeed welcome) consequences of this trend is that national governments have recognized that their taxation systems are not merely tools to raise revenue, but are also key factors in attracting inward investment.

In the last five years or so, the United Kingdom has firmly embraced this philosophy. There have been a number of significant reforms that substantially increase the country's competitiveness on the world tax stage.

Corporate tax

In common with many countries, the U.K. has lowered its corporate tax rate, from 52% to 33%. The 33% rate was in fact the lowest general corporate tax rate in the EU until Sweden and Finland (with rates of 28% and 25%, respectively) joined the Union at the beginning of 1995.

The U.K.'s effective tax rate can be even lower when dividends are repatriated to a U.S. shareholder, through the U.K.'s Advance Corporation Tax (ACT) system. When a U.K. corporation pays a dividend, it is required to make an additional tax payment (ACT) currently equivalent to 25% of the dividend. As its name would suggest, this advance tax payment may be set off against the company's final gross mainstream corporate tax liability.

Under the U.K./U.S. tax treaty, a U.S. shareholder is able to recover part of the ACT. A corporation owning a least 10% of a U.K. company can in fact recover half of the ACT, less a 5% withholding tax. The overall effect is that on distributed profits the effective U.K. tax borne by a U.S. shareholder, after taking the refund into account, is 28.4%.

The Xerox case

The treatment of U.K. dividends for U.S. foreign tax credit (FTC) (Sec. 902 deemed paid credit) purposes can be complex, as was recently highlighted in Xerox Corp., Fed. Cir., 1994. Before the Xerox case, in general terms, an indirect credit under Sec. 902 was given for the gross mainstream tax paid on the profits when a dividend was sourced, including any ACT (except the half refunded under the treaty) used to offset, or reduce, the gross mainstream tax liability. When, for whatever reason, the ACT was paid on a...