The Government redoubled its efforts to prevent a flood of businesses quitting the UK yesterday as it abandoned a plan to tax British companies on the profits they generate overseas.

In his Pre-Budget Report, Alistair Darling said dividends paid by companies' overseas subsidiaries would be exempt from tax as from next year.

He said the Treasury would offset the extra cost of the concession by imposing a limit on the amount of interest on debt repayments that companies can offset against their tax liabilities.

He said the Government would consult further on the best way to tax multinational companies on the profits they generate overseas.

Darling's £1 trillion debt gamble

Alistair Darling stored up big tax rises for the better-paid and huge public spending curbs in his fight against recession. Watch video

• Need to know: Pre-Budget Report

• Shot in the arm for economy may prove a shot in the dark

• Parties reveal their battle lines for the next election

Life on Recession Road

The people of Marlow Road in Maidenhead, London give their verdicts on the economy

Related Links

• Lloyd's boss Levene attacks tax 'dithering'

• Companies move abroad to escape tax

"I will introduce an exemption for foreign dividends in 2009 for large and medium businesses, and improve our rules for taxing controlled foreign companies," the Chancellor said.

The move, at an estimated cost to the Treasury of £275 million, marks the latest climbdown by the Government, which has faced open hostility from corporate Britain about the unfairness of the domestic tax regime.

A string of companies have either moved their corporate headquarters overseas or threatened to do so. They include Sir Martin Sorrell's advertising giant WPP, publishing firm UBM and Henderson, the fund management group.

Sir Martin told The Times that uncertainty still surrounding the issue of how to tax foreign profits. "The good news is that they are looking at the issue, the bad news is that there is no definitive detail and, as as a result, no certainty," he said.

Alex Henderson, tax partner at PricewaterhouseCoopers, said: "This is a balanced measure, which is only scheduled to cost the Treasury £175 million [after offsetting other effects] but it is welcomed as a step in the right direction. We would hope for more in the budget in the spring."

Mr Henderson said the concession was one of only a few made for British businesses in a pre-budget report that was heavily directed at cash-strapped consumers.

However, Chris Sanger, head of tax policy at Ernst & Young, said the introduction of the cap on debt interest that could be offset against tax would add to businesses burdens. "The adoption of a worldwide debt cap could make the UK far less attractive for overseas investors and lose the UK its prime position as a recipient for foreign direct investment," Mr Sanger said.

The new rules mean that companies should find it easier to repatriate capital generated overseas. According to KPMG, the vast majority of big businesses would do this if foreign dividend payments were tax exempt.

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive