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Government blocks avoidance involving manufactured overseas dividends

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An avoidance scheme in which the recipient of a manufactured overseas dividend (MOD) seeks a credit for UK income tax where ‘no actual UK income tax has been paid’ is to be blocked with effect from 15 September.

Finance Bill 2012 will clarify the corporation tax treatment of MODs received by companies, said David Gauke, the Exchequer Secretary to the Treasury, in a written ministerial statement.

The government expects the measure to increase tax receipts by about £40m a year.

What is a manufactured overseas dividend?

‘The amendment will ensure that MODs cannot be used to obtain repayment or set-off of income tax that the UK Exchequer does not receive,’ Gauke said.

‘The clarification follows disclosure of a new avoidance scheme in which the recipient of a MOD claims to have received it under deduction of UK income tax, which it then seeks to set off against its corporation tax liability, or to have repaid, although no actual UK income tax has been paid.

‘This measure protects significant amounts of revenue. Any yield from this measure will be reflected in the OBR’s next forecast.’

HMRC have published draft legislation and an explanatory note.

Gauke said the new rules would put it ‘beyond doubt’ that no set-off or repayment of income tax can be made in such cases.

He added that because of ‘repeated avoidance in this area’ the government will consult after Budget 2012 on proposals to make wider changes to the MOD rules.

‘The government recognise that changes to these arrangements could affect financial markets and they are committed to full consultation on any changes, which would have an appropriate lead-in period. Any changes made following the consultation would not come into effect before 1 April 2013.’

What is a manufactured overseas dividend?

HMRC’s background note to the draft legislation says:

‘Financial traders and other participants in the financial markets commonly transfer shares on a temporary basis from one party to another as a form of secured loan or to gain access to specific securities. Payments known as manufactured overseas dividends (MODs) are often made by the temporary holder of shares to the original owner as compensation for the dividends arising on the shares which are received by the temporary holder.

‘Where a MOD is paid, the payer must deduct a sum representing income tax equal to the relevant withholding tax on the MOD. A company receiving a MOD from which tax has been deducted is treated as if it had received an overseas dividend paid after withholding a certain amount of overseas tax. The amount of overseas tax treated as withheld can vary between nil and a maximum of the amount deducted.

‘Where the amount treated as overseas tax is less than the amount deducted, it has been suggested that the difference between the two amounts should be treated as income tax, available for set-off or repayment. This is not in the view of HMRC the effect of the legislation but [the proposed amendment] puts it beyond doubt that it is not treated as income tax.’