Modernising the taxation of distributions and repayments of capital from companies

Question 1

Summary

Accepted Answer

Subject of this consultation

This consultation seeks views on proposals to modernise the tax framework dealing with distributions made by companies to shareholders who are individuals or trusts.

Scope of this consultation

The government is consulting on:

proposals to review the treatment of ‘new consideration’ and ‘repayments of capital’ in certain scenarios
proposals to align the tax treatment of distributions from non-UK resident companies with that of distributions from UK resident companies
proposals to review the interaction of the distributions regime with the loans to participators regime, and how the loans to participators regime might be extended to cover loans received from non-UK resident companies
proposals to reform the demergers provisions, the Purchase of Own Shares (POS) relief, and the Transactions in Securities (TIS) rules

This consultation is focused on situations where the shareholder is within the charge to Income Tax; the proposals are not intended to affect corporate shareholders directly.

Who should read this

This consultation will be of particular interest to companies and their shareholders, tax agents and other bodies with an interest in corporate taxation.

Duration

The consultation will run for 12 weeks starting on 23 June 2026 and ending on 14 September 2026.

Lead official

The lead officials are S Martinez, C Bryson, C McCarthy and J Phillips of HM Revenue and Customs (HMRC).

How to respond or enquire about this consultation

Any responses to or queries about this consultation should be sent by email to distributionsreform@hmrc.gov.uk.

Respondents do not have to respond to all the questions in this document. HMRC welcomes full responses or partial responses focused on the individual aspects that are most relevant to the respondent.

Additional ways to be involved

HMRC welcomes discussions with interested parties. If you would like to be involved in these, please email distributionsreform@hmrc.gov.uk.

After the consultation

The government will analyse the consultation responses and publish a summary of responses after the consultation closes. The government may seek to engage in further consultation on specific reforms.

Getting to this stage

This is a new consultation announced at Tax Update 2026.

Previous engagement

This is a new engagement with stakeholders on this subject.

Question 2

1. Introduction

Accepted Answer

The tax rules surrounding interactions between companies and their shareholders, including those establishing the nature, timing, and quantum of distributions, have remained largely unchanged since the introduction of Corporation Tax in 1965.

These rules are extremely broad and are intended to capture any extractions of value from a company to a shareholder in respect of their shareholding, or in respect of debt instruments with equity-like characteristics. These rules are subject to particular exemptions such as when the extraction is in return for new consideration or is a repayment of capital.

While the rules generally operate well, the commercial and legal environment in which they apply has undergone significant change. There are some scenarios where they produce distortions and result in substantively similar payments receiving different tax treatment.

For example, the charge to Income Tax on dividends from non-UK resident companies developed separately as a charge on income from foreign possessions and is not aligned with the wider charge to Income Tax on dividends and other distributions from UK resident companies (see Chapter 4).

Extractions which do not fall within the charge to Income Tax often result in capital distributions, which are instead subject to Capital Gains Tax (CGT). This affects both the amount of the extraction that is taxed and the tax rate at which it is charged. The result is that economically similar payments to a shareholder can be taxed inconsistently.

The government is therefore considering how the rules could be modernised to ensure they operate as intended and do not give rise to distortions, without undermining commercial practice. This is intended to produce a cohesive system that taxes equivalent payments in more consistent way.

There are 7 chapters covering the proposals:

Chapter 2 explores how tax planning around ‘capital on the shares’ within the distributions regime can be used to create outcomes not envisaged by legislation and seeks views on potential options to reform the rules.

Chapter 3 looks at the existing demerger relief rules and explores whether these could be better targeted.

Chapter 4 covers the Income Tax treatment of dividends and other distributions from non-UK resident companies and seeks views on aligning this with the treatment of dividends and other distributions from UK resident companies.

Chapter 5 looks at the interaction of the distributions regime with the treatment of debt and loans and proposes introducing a priority rule as to when extractions should be charged under the loans to participators regime.

Chapter 6 looks at loans from companies that are not UK resident but otherwise would meet the close company criteria and considers introducing rules to address long term extractions.

Chapter 7 addresses the POS rules and suggests changes to bring more clarity and ensure the rules remain appropriately focused.

Chapter 8 considers the TIS provisions and how these could be modernised to better tackle avoidance.

These proposals are being consulted on because of their complexity and the need for the government to have a clear view of the impacts of any change before proceeding. We will only move forward with these proposals after consultation where doing so is in line with the government’s objectives. This means ensuring that commercial activity is not adversely affected and wider impacts on growth and investment are fully considered.

While there are questions specific to each chapter, there are several broad areas which the government invites respondents to reflect on throughout.

The distributions rules are strongly linked to underlying company law, and how such foundational regulation operates both in the UK and overseas can often be highly relevant. The government welcomes input from stakeholders to ensure the proposals are effective and practical.

The proposals are not intended to impact legitimate commercial restructurings, and the government is keen to understand the wider impacts of these proposals on corporate groups, their owners and how they choose to operate.

Many definitional provisions under consideration will apply equally to taxpayers within the charge to Corporation Tax as to ones within the charge to Income Tax. The focus of this consultation is where the shareholder is an individual; the proposals are not intended to affect corporate shareholders directly. The general exemption from tax under Part 9A Corporation Tax Act (CTA) 2009 should ensure this, but the government welcomes responses highlighting unintended consequences.

Question 1: How do any of the proposals outlined in this document impact Corporation Tax payers?

Question 3

2. Reduction of capital

Accepted Answer

In most cases where companies carry out a reduction or return of share capital, such as share buybacks, any payment received by shareholders is chargeable to Income Tax as a distribution to the extent that the amount received exceeds the capital contributed to the company by the original subscriber (the legislation looks to the ‘new consideration’ provided for the shares), under S1000(1)B CTA 2010. This ensures shareholders are taxed on all extractions of value from a company to the extent they exceed the amounts originally paid for the shares. It limits shareholders from receiving cash in capital events in preference to distributions.

A shareholder can extract value (including accrued profits) from a company by paying themselves a dividend, which would be subject to Income Tax. They may also use restructuring to facilitate the withdrawal of value in a form chargeable to CGT at a lower rate of tax.

The POS relief (as detailed in Annex C) provides for situations where the government intends this capital treatment to be available. But well-advised taxpayers can restructure to achieve capital treatment even where the POS requirements are not met. This can result in 2 substantially similar transactions having different tax outcomes.

Example of capital reduction

There are various arrangements which can be used, and this example sets out one of the more common ones. Annex A contains further discussion.

John owns the entire share capital of ‘Old Co’, having originally subscribed for it for £100.

Old Co’s balance sheet and reserves have grown over time, and the company is now worth £2 million. John anticipates making an exceptional payment to himself and seeks advice on how to achieve the best tax outcome.

Following this advice, John:

incorporates ‘New Co’ with one share
disposes of his shareholding of Old Co to New Co in exchange for 99 shares

This is a share for share exchange under S135 TCGA 1992, and so the gain is deferred against his new shareholding (see Annex B). The anti-avoidance rule in S137 TCGA is not triggered, so the relief is available in full.

For CGT purposes, the base cost of John’s shares in New Co reflects the base cost of his shares in Old Co (£100) in addition to the subscription price of his original share in New Co; however, the capital on the shares of New Co matches the market value of Old Co at the time it was transferred into New Co (£2 million). The capital includes share premium for the purposes of the distribution rules and is represented by the value transferred into the company for the new shares.

Two years later, the company is now worth £4 million, and John wishes to take the exceptional payment. He decides to access £2 million by reducing his capital by 50% (50 out of 100 shares in New Co) and reducing his share premium by £999,950.

The relief under POS is not available as John has not reduced his interests in the company sufficiently and remains connected to it. However, he will still be chargeable to CGT up to the amount of his capital contribution, and only the excess of his base cost will be chargeable to Income Tax as a distribution.

This leads to the following Income Tax scenario on John:

Cash (50% of New Co)	£2,000,000
Capital on the shares of New Co (50% of the share capital transferred into the company)	(£1,000,000)
Taxable as a distribution	£1,000,000

With the accompanying CGT computation:

Proceeds (Capital on the shares of New Co)	£1,000,000
Base Cost (50% of the deferred base cost from his original shareholding)	(£50)
Capital Gain	£999,950

The particulars of this scenario are explained in more detail in Annex A.

John has taken funds from his company, which has not stopped trading and which he still owns in the same proportion as before, while paying CGT rather than Income Tax on a large portion of the extraction. This has led to a reduced tax bill compared to the position as if he had extracted those funds as a dividend, which may be yet further reduced if there are CGT reliefs, such as Business Asset Disposal Relief (BADR), or capital losses available.

Proposed changes

The government intends to reduce the scope for companies to use the existing rules to extract value from continuing businesses at capital rates.

It is proposed that share buybacks and other returns of capital reflect a ‘frozen’ amount of capital on the shares in any future holding companies at the amount subscribed on the original investment, thereby matching the CGT deferment of the original base cost.

Applying that to John’s situation above, the Income Tax computation would be:

Cash to John	£2,000,000
Frozen capital on the shares of Old Co (50% of the original investment)	(£50)
Taxable as a distribution	£1,999,950

With the accompanying CGT computation:

Capital on the shares	£50
Base cost (50% of the deferred base cost from his original shareholding)	(£50)
Capital gain	£0

This change reflects the reality of John’s structure, and leads to the same outcome as if he had attempted to sell back his shares in his original Old Co, without the involvement of New Co. This will ensure that the rules applying for both CGT and Income Tax adopt the same approach, removing the possibility of asymmetric outcomes and preventing their use in tax planning structures. It will also reduce the significance of the TIS rules in these cases by producing a clear, consistent outcome that is not dependent on the requirement to establish a tax advantage purpose or on HMRC counteraction activity. See Chapter 8 for discussion of the TIS rules.

Question 2: What general comments do you have on the proposal to modernise the rules determining the size of a distribution on a reduction of share capital or share buyback?

The government recognises that the proposal might potentially lead to unfair outcomes in certain circumstances. Since the proposal is to limit the value of the share capital in both the original and holding company, then a return of capital would be limited to the value of the initial share subscription in relation to both companies. This would not be an issue where the original company undertakes a share buyback if this structure remains unchanged, as the distribution would be exempt from Corporation Tax in the hands of the new holding company under Part 9A CTA 2009. However, should the holding company sell shares in the original company, by default the capital on the shares would remain frozen in the hands of any purchaser, which may lead to unfairness in the event of a subsequent share buyback if the new shareholder is liable to UK tax on that receipt.

The government invites comments on the impact of the proposal where the shares are sold at arm’s length to a third party. Any exceptions to the rules would need to be carefully balanced to ensure they don’t facilitate avoidance.

The government also recognises that this proposal may cause issues where share for share exchanges take place within corporate groups or the Substantial Shareholder Exemption (SSE) applies. The government welcomes thoughts on the issues that this may cause, and suggested mitigations. The government also recognises that this will impact non-statutory demergers, which is discussed at more length in Chapter 3.

It is important that shareholders attempting demergers or share restructuring for legitimate business purposes are not affected by the proposal. The government welcomes input into countering any other newly created unfair outcomes.

Question 3: Please describe how this proposal might impact legitimate corporate demergers and share restructuring.

Question 4: Can you anticipate any other unintended or unwelcome consequences of this proposal, such as on third party sales?

Question 4

3. Demergers

Accepted Answer

Corporate businesses — companies, or groups of companies — may choose to divide and continue to trade separately via a demerger. Without specific provisions, a demerger could lead to a taxable distribution in the hands of an individual shareholder on the basis that they would have received a valuable shareholding from the original company in their capacity as a shareholder.

The statutory demerger provisions are set out in Chapter 5 Part 23 CTA 2010 and aim to remove any tax disincentive to demerge by exempting such distributions. There are parallel reliefs under TCGA 1992 to prevent a gain being realised at both shareholder and underlying company level (including de-grouping charges).

However, even where they don’t meet the requirements for the statutory demerger relief, companies and groups are currently able to use restructuring to achieve the same effect, relying on the same share for share exchange arrangements as discussed in Chapter 2 (particularly in ‘liquidation demergers’ under S110 Insolvency Act 1986 and capital reduction demergers). A walkthrough example of a capital reduction demerger is shown in Annex E.

The proposal in Chapter 2 would remove the capital reduction route used by corporate businesses to carry out non-statutory demergers, increasing reliance on the statutory route. The government recognises that the demerger relief is not currently well-used and therefore wishes to re-examine the rules to ensure their effectiveness and so that they do not act as a barrier to business evolution.

The conditions for statutory demergers are listed in Annex E. The government intends to liberalise these conditions and to provide clarity, to minimise disputes and allow business to operate more freely. In some cases, the changes are loosely based on the broad principles that HMRC currently applies when considering whether to grant clearances. In other cases, the proposed changes go further than existing practice and will allow the relief to be used in a wider variety of circumstances.

The government is considering the following changes:

condition A would be removed, with the effect that there would be no requirement for all companies to be resident in the UK or in a member state
condition B would be updated to include investment companies — the majority of references to ‘trade’ in the statutory demergers legislation would be expanded to also include ‘activity’
condition C would be removed from legislation due to redundancy
condition G would be removed in order to legislate commonly accepted practice
condition I would be relaxed and limited to ‘immediately after the transaction’
conditions E, H and J would be amended to the effect that ‘all or substantially all’ would be replaced by ‘all’, in order to provide clarity
condition K would be relaxed to allow the distributing company to be dissolved post distribution, provided that it contains no assets including cash or loans — the exemption from Condition K in cases whereby the distributing company is a 75% subsidiary of another company would be removed due to redundancy
conditions L and M would be removed due to redundancy, as internal group distributions would be exempt in the hands of corporate shareholders under most circumstances

The government is considering creating easements within parts of Condition D to prevent over-reliance on non-statutory practices and to allow for better certainty for businesses in their long-term planning.

condition D currently stipulates that no demerger can be used to facilitate an onward sale — this would be changed so the restriction applies to onward sales within 5 years of the demerger, without the restriction applying after that period (there would be an exception to the 5-year restriction for cases where all trading activities are disposed of)
condition D also requires that there should be no change of control after a demerger — in order to allow for better succession planning, this would be amended to stipulate that there should be no change of control within 5 years of the demerger (this would legislate what is commonly accepted as normal succession planning in family businesses, which would otherwise be obliged to use a non-statutory route)
condition D stipulates that the demerger must not be to facilitate the cessation of trade after the distribution — this would be replaced to the effect that within 5 years of the distribution there may be no dissolution or winding up of the company, with an exemption covering cases where this is not done voluntarily

Given that the conditions are intended to be relaxed and areas of legislative ambiguity clarified, the government is also proposing to remove the right to apply for automatic appeal by Tribunal should a clearance request be denied.

Question 5: In what scenarios would you currently undertake or recommend a non-statutory demerger? 

Question 6: Do you think that the statutory demerger rules ought to apply to a broader scope of transactions? 

Question 7: What comments and suggestions do you have regarding the amendments suggested above to the statutory demerger legislation? 

Question 8: Are there any other specific parts of the legislation which you think the government should re-examine?

Question 9 In what way do you think the demerger rules ought to be liberalised in order to account for the removal of capital demergers? 

Question 10: Do you anticipate any unintended consequences as a result of the proposals set out in this chapter?

Question 5

4. Income Tax treatment of distributions from non-UK resident companies

Accepted Answer

Distributions are charged to Income Tax under different rules depending on whether the distributions are sourced from UK resident or from non-UK resident companies.

For distributions from UK tax resident companies, a broad statutory definition is used. This is underpinned by detailed rules (Part 23 CTA 2010) covering a wide range of transfers and transactions to, very broadly, ensure that extractions of value from continuing companies are charged to Income Tax and that the right amount is brought into account. There are specific rules dealing with particular situations such as stock dividends.

In the case of distributions from non-UK resident companies, the charge to Income Tax is much narrower, and only dividends which are not of a capital nature (see Annex F) are brought into account. Where an Income Tax charge doesn’t apply, the distribution is instead charged as a capital receipt.

The result is that two substantially similar payments to a UK resident shareholder can be treated very differently for tax, with the one from a non-UK resident company having a more favourable tax treatment than the one from a UK resident company. This can incentivise businesses to utilise non-UK resident companies rather than UK resident companies and to extract money in forms other than dividends.

The proposed change

The government is exploring aligning the tax treatment to remove this distortion. This aligned treatment already applies to recipients subject to Corporation Tax and is well understood, with a clear demarcation between income and capital.

The government is therefore proposing to extend the Income Tax charge to A, B, G and H distributions as defined under S1000(1) CTA 2010. These include:

all dividends
all other distributions out of the assets of the company in respect of shares
transfers of assets or liabilities between the member and the company
certain bonus shares issued after a share buyback

It would also extend to stock dividends.

The government is also considering whether to extend the Income Tax charge to C, D, E and F distributions as defined under S1000(1) CTA 2010 and to what extent. These include:

the issue of redeemable bonus shares or bonus securities
interest or other payments on debt with equity characteristics, such as securities which are special securities

The distribution rules tax redeemable bonus shares and bonus securities at the point of issue, with further tax charges becoming due on redemption. For bonus shares in particular, it may be difficult for shareholders to identify when these have been issued when the company is not UK resident and where the nature of the instruments in the company is different to that under UK corporate law.

The rules on debt with equity characteristics were developed with the aim of balancing the treatment between the company and the creditor as well as taxing extractions by shareholders. Where a UK resident company makes a payment on these instruments, they would not be able to obtain a deduction for Corporation Tax where the payment is treated as a distribution. Non-UK resident companies which are outside the charge to Corporation Tax will not be in this position.

Income Tax is also already due on many of the payments made on these instruments, such as interest income.

The government would like to understand how these instruments are used in commercial structures by non-UK resident companies where the return is likely to be paid to a person within the charge to Income Tax, such as an individual or a trust.

Companies which are incorporated outside of the UK but nonetheless UK tax resident are already subject to the same rules as other UK resident companies and would remain so.

Question 11: Do you have any general comments on aligning the charge to Income Tax on distributions from non-UK resident companies with the rules that already apply to distributions from UK-resident companies?

Question 12: Can you foresee this proposal having any impact on obtaining relief for double taxation where the distribution is subject to tax in another state?

Question 13: Do you anticipate this proposal deterring any commercial corporate actions? If so, please provide details and suggestions of how this impact could be addressed.

Question 14: Do you have any comments on the proposal to extend the charge to stock dividends? In particular, are there difficulties with the classification of shares in non-UK jurisdictions?

Question 15: Do you have any comments on extending the charge to redeemable bonus shares and securities?

Question 16: Do you have any comments on to what extent the charge to Income Tax on distributions should apply to payments on special securities and non-commercial securities?

Question 17: Do you have examples of where instruments that would be treated as special securities and non-commercial securities are used in existing structures where the return would be paid to UK residents within the charge to Income Tax?

Potential issues with return of capital and similar situations

Whether payments are dividends, and whether or not those dividends are of a capital nature, is a question of UK law determined by reference to the characteristics of the transaction under the law under which the company is incorporated and the legal mechanism by which the payment is made. Other jurisdictions’ company law can often be significantly different to UK company law. This can lead to costly and time-consuming uncertainty for taxpayers and to disputes with HMRC.

Given this background, the government is exploring how the underlying definition of distribution in Part 23 CTA 2010 could be improved to ensure it operates as effectively as possible in relation to distributions from non-UK jurisdictions with their own company law codes.

The government would welcome discussion of the tension in the current treatment of distributions from non-UK resident companies between whether a payment is a dividend, or a return or repayment of capital. The distribution rules in Part 23 CTA 2010 were primarily drafted with UK company law in mind and, in particular, the maintenance of capital principle. The company law governing non-UK entities may be very different and have categories of distribution which are difficult to reconcile to UK legal concepts.

While aligning the treatment of distributions from non-UK entities with UK entities may reduce some of these difficulties, the definitions still draw the distinction between a ‘dividend’ and ‘any other distribution.’ If a payment is a dividend, the entire payment is within the charge to Income Tax, whereas other distributions are reduced by the amount of share capital repaid or new consideration provided. As set out above, this is determined by the characteristics of the non-UK resident entity by reference to UK law. The government is exploring whether greater clarity could be provided by introducing provisions that deem a payment to be a dividend or other distribution if certain factors are present to address situations where the treatment is unclear.

The government also wishes to explore options relating to payments from non-UK resident companies which would otherwise be close. These are set out in Chapter 6.

Question 18: Do you have any comments on the potential tensions between the definitions used in the UK distributions rules and non-UK corporate legislation, especially with regard to the distinction between income and capital? In particular, are there any difficulties around what constitutes a ‘repayment of capital’? How could these be addressed?

Question 19: Do you have any insights from other jurisdictions which also use the capital/income divide in their tax legislation?

Question 20: Are you aware of any particular existing difficulties around whether a distribution from a non-UK incorporated company is a ‘dividend’? Should the government consider introducing provisions to clarify the treatment where the non-UK company law is unclear?

In addition, the government is aware that non-UK resident companies may not provide their shareholders with the information necessary to compute the quantum of a distribution for UK tax purposes, particularly when there is share premium or the equivalent under local law which may be taken into account in establishing how much of a distribution is a repayment of capital. For example, small shareholders in widely held or quoted non-UK companies may not have the necessary information to determine the capital on the shares they hold. In such a case it could be provided that, as long as the shareholder reasonably believes the shares have been fully paid up, a relevant distribution can be calculated using their nominal value.

Question 21: When calculating what amount of a distribution is a repayment of capital, would it be effective to permit small shareholders in widely held or quoted companies, who do not have access to the necessary information, to simply use the nominal value of the interest they hold on a share buyback? Are there any difficulties with calculating the nominal value of the share in some jurisdictions?

Question 6

5. Interaction between debt, loans and the distributions legislation

Accepted Answer

The rules for determining when a taxable distribution is made are intentionally wide, covering the transfer of any value by a company to its shareholders in that capacity (whether directly or indirectly).

This means that an amount may be subject to tax as a distribution even where the payment may not be properly made under company law. This improper extraction may not be identified until several years after the payment has been made, such as during a due diligence process when a company is being sold, and may result in an obligation for the recipient shareholder or responsible director to account for the funds to the company. In some cases the error may never be identified. See Annex G for an example.

The existence of any obligation to repay the company is a complex area of corporate law, and is fact specific and open to dispute based on the circumstances and motives of the director or recipient. The impact this has on the distribution position may lead to costly litigation with HMRC.

Interaction with the loans to participators regime

The uncertainty of this area of law can allow for both exploitation of the Self-Assessment framework to avoid paying tax and situations where taxpayers pay more tax than they should.

If the company in question is close (broadly, controlled by five or fewer participators or by directors who are participators), it will be subject to the loans to participators regime at Part 10 CTA 2010. An obligation to repay an unlawful dividend will result in a charge to tax on the company under S455 CTA 2010 on the basis that this is a debt incurred by a participator in the company from which the funds or assets were extracted.

Whilst the extraction is in an uncertain legal position, it may resolve to be either:

a distribution chargeable to Income Tax on the participator
an unlawful payment which they argue is not chargeable to Income Tax, which will result in a charge on the company under S455

The point in time when this becomes apparent may be some years after the event, normally in the course of an enquiry into either the participator or the company. Should an enquiry be open into one of these parties but not the other, the time limits may have passed to make any amendment to the return of the party which was not open.

HMRC sees cases where this timing mismatch is used to try and avoid any charge to tax, and conversely where it leads to a charge on the participator and the company. In both situations this can lead to costly disputes and litigation.

The government would like to understand the situations faced by businesses in practice and how they address these issues.

Question 22: Are you aware of instances where dividends or other distributions have been improperly paid? If so, were the distributions repaid to the company and on what timescale? What was the tax treatment generally adopted on the repayment?

To avoid these disputes, the government intends to provide greater clarity in this area by legislating to bring the distributions code and loans to participators rules into a closer alignment such that extractions of value in favour of shareholders are clearly charged under one set of rules.

The government is exploring proposals to introduce rules establishing the priority of the relevant charges. This could involve some combination of the following options:

Option 1: establishing a priority rule

There may be some difficulty in establishing the correct treatment of the distribution, particularly if some time has passed since the original payment. The aim of a priority rule would be to provide certainty on this and ensure that tax is due at the time the value is extracted from the company.

Such a rule could set out that an obligation to repay an amount received as a result of an unlawful or unintentional distribution will not reduce the amount that is brought into account for Income Tax purposes as a distribution unless the company has recognised the debt and pays, or has paid, the charge due under S455 on that amount within a certain period of time. This could be either from the time of the discovery that the distribution was unlawful or from the time of the original distribution.

Alternatively, the rule could provide that the company will not be liable for S455 to the extent that the distribution has been charged to Income Tax.

The government is aware that there may be difficulties in matching the shareholder and company liabilities, particularly where there are multiple shareholders and there may have been changes in ownership since the original payment. However, as this is limited to close companies, in practice, such extractions are more likely to arise where the shareholders have a significant degree of control and oversight over the company’s funds. It should therefore be possible for companies and shareholders to obtain evidence that tax has been paid in order to claim relief.

Option 2: legislating the current discretionary practice of allowing the unwinding of unintentional distributions

A further potential solution is to put the discretionary practice set out in guidance at CTM15295, and reproduced in Annex H, on a statutory footing, introducing clear conditions to prevent avoidance. This would allow the unwinding of unintentional gratuitous transfers. An example may be where a shareholder sells a property to a company for more that its market value.

Broadly, this practice allows for a transfer to be unwound if there was no intention that there be a distribution and the parties made reasonable efforts to carry out the transaction at market value. This involves either repaying the company the excess or unwinding the transaction entirely.

While this would address entirely unintentional distributions, it would not address intentional extractions of value which were later found to be improperly made.

Option 3: enabling Income Tax paid on extractions to be set off against liabilities incurred on rectifying the payment

A dividend or distribution is chargeable at the time it is paid or is made. This means that if an extraction has been made improperly and is later regularised, this may result in a second charge to Income Tax. Depending on the timing, a shareholder may not be able to claim relief for the tax paid on the original distribution.

The government would like to explore whether, in such a scenario, the shareholder could set off any Income Tax paid in previous periods against any liability on any new distributions arising from rectifying the situation, such as declaring dividends to clear the debt or completing a valid share buyback. There are similar rules already in place to take into account tax paid on ‘CD distributions’ (the issue of bonus redeemable preference shares or securities otherwise than for ‘new consideration’) upon the redemption of the shares or securities in question (S401 ITTOIA 2005).

This would prevent double taxation and facilitate shareholders and directors complying with company law. It would also ensure that the tax is charged at the point value is extracted from the company.

Question 23: Would priority rules to establish what the primary charge will be on an extraction address the issue? Are there any adverse consequences to this?

Question 24: Do you have any views as to whether legislating for the current discretionary practice of unwinding unintentional gratuitous transfers would provide a solution?

Question 25: What are your views on allowing Income Tax paid on an unlawful distribution to be set off against liabilities incurred on rectifying the issue?

Question 26: What alternative solutions might be implemented to address the issues raised in this chapter?

Question 7

6. Loans and other temporary extractions from non-UK resident companies

Accepted Answer

The loans to participators regime at Part 10 CTA 2010 charges close companies at the dividend upper rate on loans or advances made to and debts incurred by participators and their associates. Close companies are, broadly, UK resident companies which are controlled by five or fewer participators or by any number of directors who are participators.

This long-standing regime recognises that loans to shareholders (and other persons with an interest in the capital or income of the company) can represent the extraction of profits from the company that would otherwise not be charged to tax. It applies a temporary tax which will be refunded to the company when either the loan or advance is repaid to the company (by any person), or when the company releases or writes off the debt. The provisions relating to the release or write off recognise that the extraction has become permanent and bring the quantum of the debt into charge for Income Tax as though it is a distribution.

There is no equivalent charge on loans or advances made by closely controlled non-UK resident companies. This means that a shareholder or associate can take funds from those companies for personal use on a long-standing and often permanent basis without incurring a tax charge.

As part of the wider proposal to reform the tax treatment of distributions from non-UK resident companies outlined in Chapter 4, the government is considering whether to introduce a regime for loans or advances made by non-UK resident companies that would otherwise be close to their participators and associates of participators. This would apply to loans or advances from companies that would be close if they were UK resident.

The close company definitions are written broadly, such that it should not be onerous to determine whether a person is a participator in an overseas company that would be close if it was UK resident. A number of rules relying on these provisions, such as the TIS rules, already require customers to assess whether non-UK companies would be close if they were UK resident. It is also necessary to consider the position of any overseas holding companies in determining whether UK resident subsidiaries are close.

Non-UK resident companies are not usually within the charge to UK tax, therefore it would likely not be possible to replicate the existing loans to participators rules and have the tax charge be on the company. Any charge on the loan or advance, and the relief due upon repayment, would need to be on the UK resident person and paid through their tax return. The timing of any charge would similarly follow the tax year and self-assessment framework.

Question 27: Given that the tax would need to be paid by individuals rather than by the companies making the loans, would this result in particular administrative difficulties? If so, please provide examples. 

The government is considering the following options:

A charge under S455 CTA 2010 arises on the loan or advance and is paid by the individual that receives it if it is outstanding at the 31 January after the end of the tax year in which it is made. Any release or write-off of the loan or advance would be chargeable under S415 of the Income Tax (Trading and Other Income) Act (ITTOIA) 2005 in the same way as a loan or advance from a UK resident company.
A charge under S455 CTA 2010 arises on the loan or advance and is paid by the individual if it is outstanding after a set period from the time the loan was made, for example, 3 years. Any release or write off would be chargeable under S415 ITTOIA 2005.
No charge is due on the loan or advance as it arises, but any release or write-off of the loan or advance would be chargeable under S415 ITTOIA 2005.
Alongside option 3, the loan is deemed to be released or written off if it has not been repaid to the company after a set period of time, such as five years.

The government acknowledges that the loans to participators and close company rules are wide-ranging and may apply to commercial transactions and structures which may not be envisaged in a parallel UK resident instance. We welcome views as to how to target this proposal at loans which represent extractions of profits in lieu of taxable payments.

One option is to limit it to loans to participators or associates with a material interest in the overseas company as defined in S457 CTA 2010: control, with their associates, of 5% of the ordinary share capital, voting power or such rights as would entitle them to receive over 5% of the assets of the company in a winding up. This could also include a specific exclusion for associates who are partners in a partnership.

A further option is to broaden the existing exclusion for loans or advances made in the ordinary course of business.

Question 28: What general comments do you have on the proposal to introduce a temporary tax on loans received from non-UK resident closely controlled companies?

 Question 29. Do you have any specific comments on the four options outlined above? Do you have any suggestions as to what time periods would be appropriate?  

Question 30: The close company definition is extremely broad. Can you see this proposal affecting loans made on arm’s length terms to participators with very minor interests, and if so, can you provide examples? 

Question 31: What impacts would the proposal have on arm’s length commercial lending?

Question 32: Would limiting this charge to participators and associates of participators with material interests in the overseas companies help to target this at loans which represent extractions of profit? 

Question 33: If we expand the exclusion for loans or advances made in the ordinary course of business, what changes would be necessary to avoid curtailing normal commercial activity?

Question 8

7. Purchase of Own Shares rules

Accepted Answer

Where a company makes a purchase of its own shares, any excess paid over the amount of capital originally subscribed for the shares is generally a distribution. However, there are special provisions in S1033 CTA 2010 that can enable a company to undertake a purchase of its own shares without making a taxable distribution.

The POS rules, as detailed in Annex C, govern how distributions to shareholders of close companies should be treated for tax purposes when the company purchases that shareholder’s shares. If the requirements are met, such payments are taxed as capital rather than as a distribution.

The relief is intended to facilitate the departure of a shareholder from a company for the benefit of the company’s trade.

The current rules relate largely to satisfying a subjective ‘trade benefit test’ which is explained in HMRC’s Statement of Practice 1982 and is a significant source of dispute between customers and HMRC. The government intends to replace the trade benefit test with a more mechanical set of requirements, to improve clarity.

The government is considering the following requirements:

the departing shareholder must have held a minimum of 5% of the company’s equity for at least the two years prior to their departure — throughout this time they must also have also worked for the company
the departing shareholder has to surrender their entire shareholding and any directorships on their departure — departing shareholders may no longer retain any shareholding for sentimental reasons
to allow for situations where sales take place in tranches to reflect the availability of reserves, buybacks will be covered by the relief so long as the shareholder fully exits within 2 years
the company must take reasonable steps to ensure that the consideration paid for the shareholding does not exceed market value
the holding and working period requirements are extended to 5 years in cases where the departing shareholder retains family connections with remaining shareholders and directors — this is intended to prevent situations whereby family members are able to provide a source of capital extraction while not meaningfully working for the company
if capital treatment is awarded to the departing shareholder, and they become a director or shareholder of the company again at any time within 5 years of leaving, the relief will be withdrawn and the distribution will be chargeable to Income Tax in their original year of departure — in some cases, particularly in the case of family companies, previously departed shareholders may receive shares via inheritance; in these cases this will not result in a withdrawal of the relief provided that reasonable steps are taken to dispose of the shares as soon as practicable

These proposals relate to Condition A at S1033(2); there is no intention to change Condition B (S1033(3)).

Question 34: What general comments do you have on the proposals set out in this chapter?

Question 35: What unintended consequences do you anticipate as a result of these changes?

Question 9

8. Updated capital extraction anti-avoidance

Accepted Answer

The TIS legislation, outlined in Annex D, has remained generally unchanged since being introduced in 1960. The rules are intended to counter avoidance and ensure that extractions are taxed as income.

However, the TIS rules reflect an outdated approach to anti-avoidance legislation and can be difficult to apply, which makes them less effective than intended in relation to certain structures.

To better reflect contemporary business structures and to provide a more flexible and modern framework in which to tackle avoidance, the government therefore intends to amend or replace the TIS rules with an updated anti-avoidance regime. The new rules are expected to be clearer and more principles based. They will tackle scenarios where a taxpayer is party to arrangements that enables them to extract value from a company and avoid paying tax.

The specific design of any reform will be closely informed by discussions with stakeholders in relation to Chapter 7, as the TIS rules operate as a ‘back stop’ where structuring has been put in place to circumvent the effect of the general provisions.

The government is also aware that any new rules will need to be carefully calibrated to ensure that commercial activity is not adversely affected, such as corporate restructurings where no value is leaving the corporate sphere. However, it is important to ensure that where shareholders have a high level of control over a company, their alignment of interests is not exploited to allow shareholder returns to be shifted into CGT — or to escape tax all together — in a way which is not practically possible for shareholders in widely held entities, where they do not have the level of influence required to implement tax motivated planning at a corporate level to benefit their personal position.

Should shareholders undertake a transaction that would be countered by existing legislation, then that legislation would take effect in priority; if that other legislation is unsuccessful in countering the transaction, then this new legislation could apply. For example, where the existing legislation is sidestepped on mechanical grounds and where it can be reasonably assumed that his is to avoid a charge to Income Tax.

Question 36: What general comments do you have on the proposal set out in this chapter?

Question 37: What unintended consequences do you anticipate as a result of this proposal?

Question 10

9. Summary of consultation questions

Accepted Answer