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Winners and losers in U.K. corporate tax cut

Lex is a premium daily commentary service from the Financial Times. It helps readers make better investment decisions by highlighting key emerging risks and opportunities.

Should stock investors care about the U.K. budget? For all the hoo-ha over this annual speech by the Chancellor of the Exchequer, it seems not. Share prices between budgets move to entirely different tunes to those hollered across the chamber. For example, selling after Alistair Darling's gloomy speech in April of 2009 would have missed a 40-per-cent rally in the FTSE 100-stock index over the next 12 months. Conversely, the market plummeted by more than a quarter despite Gordon Brown's upbeat assessment of economic growth in 2002.

There is one part of George Osborne's speech on Wednesday which does matter to investors, however. That is the announcement that various business taxes will be lowered, including the headline corporation tax rate falling to 20 per cent from 2015. For listed companies, that is good news for shareholders, although the theory can become complicated and there are practical examples where tax cuts do not help.

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Returning to first principles, there are three claimants on the free cash flows generated by a company: shareholders, bond holders and governments through tax collection. Other things being equal, if taxes fall, cash flows to equity holders increases and a company becomes more valuable. But this might not always be the case. Highly leveraged companies may actually suffer because their after-tax cost of debt is a function of the tax rate (interest is tax-deductible). Likewise, companies with big deferred tax assets can be hurt by a fall in corporate tax rates.

Of course, individual investors pay personal income tax on dividends or capital gains tax themselves. In theory, these tax rates also effect the valuation of U.K. companies. George Osborne's 2013 budget was broadly neutral on this front. But at the margin, his lower corporate tax rate should be good for equities. Indeed, the FTSE 100 closed up.

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