Advance corporation tax (A.C.T.)

Updated: Aug 20, 2021

When the rules regarding corporation tax were changed in 1973 by the changeover to the imputation system, that part of the tax imputed to the persons in receipt of dividends from a company was deemed to be deducted at source when those dividends were paid. The amount so imputed was equal to the prevailing standard rate of income tax. No further income tax is therefore payable, as it was previously when profits were distributed, though recipients liable to higher rates must account to the Revenue for the difference between amount due and amount deducted at source.

Because part of the corporation tax liability has been imputed to dividends, that tax has effectively become payable in two parts. the part so deducted and the balance, which any excess of corporation tax over standard rate income tax plus the full amount payable on undistributed profits. known as mainstream corporation tax. Because the A.C.T. and the mainstream tax will be payable at different times, then different rates of corporation tax could apply to each.

The introduction of A.C.T. was intended to encourage distributions at the expense of retention of profits by companies. It did this by doing away with the old system under which distributed profits were effectively taxed twice, once by the corporation tax assessed on total profits and secondly by the deduction of income tax at source on profits distributed as dividends.

Under the new system companies must, however, be careful not to lose capital allowances, which by their nature can only be deducted from undistributed profits, i.e. the balance of profit remaining after dividends have been paid. If 90 per cent of profits are distributed only 10 per cent remain against which to set capital allowances. These cannot be used to reclaim tax imputed to the dividends paid, that tax being suffered by the members not by the company.

A further development since the introduction of the imputation system has been the much increased equity investment by pension funds, which, being tax exempt, may reclaim the tax deducted from the dividends they receive. The fact that this deprives the Treasury of a large amount of tax revenue has been a factor in the lobbying for the removal of tax exemption privileges enjoyed by pension funds.

Reference: The Penguin Business Dictionary, 3rd edt.

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James Knight
Editor of Education
James is the Editor of Education for Invezz, where he covers topics from across the financial world, from the stock market, to cryptocurrency, to macroeconomic markets.... read more.