HMRC consultation into taxation of dividends and repayments of capital

Key areas of reform

There are seven key areas where HMRC are considering reform:

• Reduction of capital - In general, individuals and trustees will be taxed to income on reductions of capital to the extent the amount received exceeds the capital contributed to the company, with any other amounts being subject to capital gains tax (CGT). HMRC are concerned that, where there are share-for-share exchanges (or similar), the amount of capital for these purposes can exceed that which was economically put in, potentially creating a favourable tax outcome for individuals. To counter this, it is proposed that capital, for the purpose of these rules, will be limited to original subscription amounts;
• Demergers – The above proposals with respect to reduction of capital will mean that capital reduction demergers (currently the most common way of implementing a demerger) will generally no longer be possible. To compensate, HMRC are suggesting relaxations to the ‘statutory demerger’ regime, but in general it does not appear that these changes will lead to a significant increase in availability of statutory demergers. As such, if these changes go through, s110 liquidation demergers may once again be the preferred route;
• Purchase of own shares – At present, to obtain CGT treatment (as opposed to income tax) on a purchase of own shares by an unquoted trading company (or by the holding company of a trading group), a number of conditions have to be met, including the subjective (and sometimes contentious) ‘trade benefit’ test. HMRC are proposing to replace this trade benefit test with a more mechanical test which broadly requires individuals holding more than 5 percent of the share capital of a company to exit completely (and permanently) in order to benefit from capital treatment;
• Distributions from non-UK companies – Individuals and trustees currently pay income tax on dividends and other distributions (as defined in s1000 CTA 2010) from UK companies but only on dividends from non-UK companies. HMRC are consulting on aligning the tax treatment to remove this difference. In part, this is because of the different legal framework under which they may be paid. HMRC are consulting on ways in which to bring the treatment of UK and non-UK distribution receipts more in line with each other;
• Loans from non-UK companies – Loans from UK companies (which are ‘close’) to shareholders are currently subject to s455 tax (payable by the company), whilst no equivalent provision exists for loans from non-UK companies. HMRC are proposing introducing a taxing mechanism (payable by the recipient) for loans by non-UK companies to UK tax resident individuals or trustees;
• Illegal distributions – HMRC are consulting on the best method (from a tax perspective) to unwind a situation where illegal distributions have been made; and
• Transactions in securities – HMRC are considering whether this anti-avoidance legislation will require updating or replacing in light of the other proposed changes.

HMRC have stated that these changes are expected to impact individuals and trustees and are not intended to have any corporation tax implications (due to the exemption from corporation tax on distributions which will usually apply).

HMRC have also said that they are not looking to make changes to the purchase of own shares rules when being used to fund inheritance tax (IHT) liabilities charged on a death, where a disposal of the shares is necessary to avoid undue hardship otherwise being caused by paying the IHT liability.

Why this matters

Taken together, the proposals will represent major changes in the way in which certain private company transactions are taxed.

Whilst the aims of the consultation make clear that the Government is not looking to disrupt legitimate commercial activity, the proposals as they stand will inevitably have commercial ramifications for businesses and their shareholders. Rules around the purchase of own shares, reductions in capital and demergers will impact the methods and availability of extracting cash from a company in a capital form. Whilst rules around bringing the treatment of distributions etc from non-UK companies in line with those of UK companies could have an impact on a number of areas, including remuneration strategies and operational aspects of employee share plans etc., and the well-established treatments for investors in certain private capital fund structures.

HMRC have made clear that they understand that this is a complex area and as such this is a genuine consultation to which they are devoting significant resource and looking to engage with relevant stakeholders. The proposals may, therefore, change (or in some cases may not be implemented at all) as a result of the consultation, particularly if they have commercial implications beyond that which HMRC currently anticipate.

That being said, if any companies or shareholders are thinking of undertaking a demerger, purchase of own shares, or have receipts from non-UK companies going to individuals or trustees (including participants in employee share plans or other equity incentives), then please discuss this with your usual KPMG in the UK contact.

For further information please contact:

• Nathan Potton
• Mark Goddard