Until recently, the United Kingdom collected a “mainstream” corporate tax of 33% from UK companies and also required them, when paying dividends, to pay an advance corporations tax, or “ACT,” on the dividend. The company was then given a credit for the ACT against its mainstream tax. If it could not use the credit, it could either carry it to another tax year or surrender it downstream for use by its UK subsidiaries.

Compaq-UK paid a dividend of £11.8 million to its US parent in 1992 and paid £3.9 million in ACT on the dividend. Compaq-UK could not use the ACT credit, so it surrendered the credit to its two UK subsidiaries, which used the credit with the result that neither subsidiary had to pay any mainstream corporate tax in 1992 and neither paid any dividends that year.

Ordinarily when a US company receives a dividend from a foreign subsidiary, it can claim a credit for taxes that were already paid on the earnings abroad. However, in this case, the IRS said no foreign tax credit was allowed in the United States because the ACT taxes were effectively paid by the two 2d-tier subsidiaries in the UK, and neither company paid a dividend. One needs a dividend from the company paying the taxes in order to release the foreign tax credits.

The US tax court disagreed. It said the ACT taxes were paid by Compaq-UK — not its subsidiaries. It said the only relevance of where the ACT credit gets used within a UK group is that it reduces the amount of that UK company’s mainstream corporate tax that might eventually also be claimed as a credit. The case was decided in mid-November.

The UK stopped collecting ACT on dividends last April. The tax was repealed in the Finance Act, 1998.