Mixer cap and changes in Corporation Tax rate

In her speech announcing the third reading of the Finance Bill, the Financial Secretary said:

'Owing to an unintended oversight, the rules for giving double taxation relief on foreign income did not get altered to reflect the reduction in the Corporation Tax rate. If that were uncorrected, some companies could face double taxation on a small part of a number of dividends received during this financial year. This technical matter obviously needs to be rectified, and HM Revenue & Customs (HMRC) will discuss the solution with business representatives to find the best possible fix. We will then address the problem in next year’s Finance Bill, with provisions backdated to 1 April 2008 to ensure that no income faces double taxation. In the meantime, HMRC will use its statutory discretion to give the necessary double taxation relief.'

This note gives some further detail about the problem that the Financial Secretary described and the process for coming to a solution.

HMRC will work with the Confederation of British Industry (CBI) and others to identify the most appropriate solution, consistent with the elimination of double taxation of dividend income and will publish draft clauses for comment.

In the coming year very little Corporation Tax liability will actually arise from dividends paid in the year, but companies will need to make quarterly instalment payments and possibly final Corporation Tax payments before any change to the law can take effect in next year’s Finance Act. For this period HMRC will not deny foreign tax credit because of this mismatch.

Further details are given in question and answer format below. If you have any questions, please contact Andrew Page.

Double Taxation Relief (DTR) on dividends – questions and answers

How is dividend income taxed when a company’s accounting period straddles a change in the Corporation Tax rate?

Dividend income is taxed in the same way as all other income. It is apportioned between the two financial years in proportion to the number of days falling in each year, in accordance with section 8 ICTA 1988. Section 834(4) clarifies that the apportionment must be on a time basis.

The effect is to tax all income of an accounting period at the average rate applicable for the whole period, including any dividend income. See HMRC guidance at CTM01405 for further detail.

For example, if a company has an accounting period to 31 December 2008, income of the period is apportioned between the 2008 and 2009 financial years in the proportion to the number of days of the period falling in each financial year. This produces a combined average rate applicable to all income of approximately 28.5 per cent.

How is the rate used in the 'mixer cap' in section 799(1)(b) defined?

The mixer cap applies by reference to the statutory Corporation Tax rate on the day that the dividend is paid (see section 799(1A)). This cap limits the amount of tax that may be taken into account as underlying tax in relation to the dividend for the purpose of relieving double taxation.

What is the effect of this mismatch?

If a dividend is taxed at a rate that is higher than the mixer cap rate, the foreign tax credit will be capped at an amount lower than the Corporation Tax arising on the dividend, so a proportion of the dividend will be taxable without relief.

Can the difference be covered by Eligible Unrelieved Foreign Tax (EUFT)?

Not if the underlying rate of foreign tax on the dividend exceeds 28 per cent before the application of the mixer cap. The excess foreign tax up to a maximum of 45 per cent will give rise to EUFT and a dividend that has given rise to EUFT cannot also claim EUFT.

What will the solution be?

The Financial Secretary has given assurance that double taxation relief will not be restricted by reason of this unintended mismatch. HMRC will discuss exactly how the problem should be solved with business representatives, but in the meantime HMRC will work on the assumption that the mixer cap applies by reference to the rate of tax actually applying to the dividend, not the statutory rate and will give relief accordingly.

Can companies rely on this assurance?

Yes. This announcement represents a binding commitment by HMRC to exercise its managerial discretion to give double taxation relief in line with the Minister’s statement.