Advance Corporation Tax (ACT) refers to a tax system that existed in the United Kingdom until its abolition in 1999. It was a form of tax paid by companies on dividends before they were distributed to shareholders. ACT aimed to collect tax revenue in advance from corporations to prevent tax evasion and ensure timely payment of taxes on shareholder dividends.
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Purpose of Advance Corporation Tax
ACT served several purposes:
- Prevent Tax Avoidance: By taxing dividends at the corporate level before distribution, ACT aimed to discourage companies from retaining profits without distributing dividends to avoid individual shareholder taxes.
- Revenue Collection: It facilitated the collection of tax revenue earlier in the financial cycle, contributing to government funds and budget planning.
- Simplicity in Taxation: ACT simplified the taxation process by consolidating tax liabilities at the corporate level, streamlining administrative procedures for both companies and tax authorities.
How Advance Corporation Tax Worked
1. Tax Credit System:
Under ACT, companies paying dividends to shareholders received a tax credit equivalent to the amount of ACT paid on those dividends. This credit could be used by shareholders to offset their personal tax liabilities, ensuring that dividends were not subject to double taxation at both corporate and individual levels.
2. Timing of Payment:
ACT was payable at the time dividends were declared or paid by the company, rather than when shareholders received the dividends. This ensured that the tax authorities received revenue promptly, aligning with the accrual principle of taxation.
Example of Advance Corporation Tax
For example, consider a fictional company, XYZ Ltd., operating in the UK during the period when ACT was in effect. In a given financial year, XYZ Ltd. generates profits and decides to distribute dividends to its shareholders. Before distributing these dividends, XYZ Ltd. is required to calculate and pay ACT to the tax authorities.
Suppose XYZ Ltd. declares £100,000 in dividends to be distributed among its shareholders. The prevailing ACT rate at that time is 20%. Therefore, XYZ Ltd. would be liable to pay £20,000 (£100,000 * 20%) as ACT to HM Revenue and Customs (HMRC).
Once XYZ Ltd. pays the £20,000 in ACT to HMRC, it receives a tax credit of £20,000. This tax credit can then be passed on to its shareholders along with the dividends. Shareholders can use this credit to offset their personal tax liabilities on the dividends received, effectively avoiding double taxation on the same income.
Abolition of Advance Corporation Tax
ACT was phased out and eventually abolished in the UK in 1999 as part of broader tax reforms. The decision to abolish ACT was influenced by several factors, including:
- Complexity: ACT added complexity to the taxation system, requiring careful administration and compliance from companies and tax authorities.
- International Competitiveness: The UK sought to enhance its attractiveness as a destination for investment and business operations by aligning its tax policies with global standards and practices.
- Impact on Investors: Abolishing ACT simplified taxation for shareholders and eliminated the need for companies to manage ACT payments and credits.
Conclusion
In conclusion, Advance Corporation Tax (ACT) was a tax system in the UK designed to collect tax revenue from corporations on dividends before distribution to shareholders. It aimed to prevent tax avoidance, ensure timely revenue collection, and simplify the taxation process. Although ACT is no longer in effect, its legacy highlights the evolution of tax policies and their impact on corporate governance, shareholder dividends, and government revenue strategies.