Policy paper

Statement of Practice 4 (1994)

Published 6 April 1994

1. This Statement of Practice sets out HM Revenue and Customs (HMRC) views on the tax treatment of enhanced stock dividends received by trustees of trusts in which there is an interest in possession - that is, trusts where 1 or more beneficiaries have a right to the whole of the income of the trust as it arises. Paragraphs 19 and 20 deal with the position of Scottish trusts.

2. A company may offer its shareholders the option of taking additional shares rather than a cash dividend. Such issues of shares are described in the statute as stock dividends, although they are also commonly known as scrip dividends. Where the number of shares issued is deliberately set so that their market value exceeds the cash alternative, the issue is known as an enhanced stock dividend (or enhanced scrip dividend).

3. On the principles derived from IRC v Blott (8 TC 101), an issue of non-redeemable shares is not a distribution for the purposes of Section 209, ICTA 1988. This means that the shares are received without any sort of tax credit. However, Section 409 ITTOIA 2005 treats certain recipients of stock dividends within Section 410 ITTOIA 2005 as having received on the due date of issue an amount of income, equal to the equivalent of the share capital grossed up by reference to the dividend ordinary rate. The cash equivalent of share capital is defined as the amount of the cash dividend alternative unless the difference between the share capital’s market value equals or exceeds 15 % per cent of that market value. Where market value applies this is determined:

• in the case of listed share capital, on the date of first dealing
• in the case of other share capital, on the earliest date on which the company is required to issue it

4. Section 409 ITTOIA 2005 can apply to an enhanced stock dividend received by trustees of an interest in possession trust (‘the trustees’) only where the beneficiary with an interest in possession (‘the beneficiary’) is beneficially entitled to it so that Section 409(4) ITTOIA 2005) applies (see paragraph 8 below).

5. Where the trustees take an enhanced stock dividend they must consider whether, as a matter of trust law, it should be regarded as income or capital, taking account of:

• all the relevant facts
• any specific provision in the trust deed

6. HMRC can offer no guidance about the application of trust law in any particular case. However, HMRC will accept whichever of the 3 approaches described in this statement of practice the trustees conclude that they should adopt, provided that their conclusion is supportable on the facts of their particular case.

7. The tax treatment of enhanced stock dividends received by the trustees follows from the trust law position. This Statement of Practice sets out the tax consequences if an enhanced stock dividend is:

• regarded as income; or
• regarded as capital; or
• regarded as capital but the trustees make a payment to the beneficiary in accordance with Re Malam, Malam v Hitchens (1894) 3 CH 578

I Enhanced stock dividend regarded as income

8. If the enhanced stock dividend is regarded as income the beneficiary is beneficially entitled to the shares comprised in the dividend and ITTOIA 2005 s 410(2) applies. The beneficiary is treated as having received income of an amount which, when reduced by an amount equal to Income Tax at the Schedule F ordinary rate, is equal to the ‘appropriate amount in cash’. No repayment of this tax can be made (ITTOIA 2005 s 414(2)). The beneficiary has no further Income Tax to pay if he is a basic rate taxpayer. A higher rate taxpayer has an extra liability equal to the difference between the Schedule F ordinary rate and the Schedule F upper rate on the income that he is treated as having received.

9. For Capital Gains Tax purposes, TCGA 1992 s 142 applies. The issue is not a reorganisation. The beneficiary is treated as having acquired the shares for the ‘appropriate amount in cash’. Under TCGA 1992 s 60 any formal transfer by the trustees to the beneficiary is disregarded. If they sell the stock dividend on his behalf, it is treated as a sale by the beneficiary.

II Enhanced stock dividend regarded as capital

10. If the enhanced stock dividend is regarded as capital there is no Income Tax liability as ITTOIA 2005 s 410(2) does not apply.

11. For Capital Gains Tax purposes, the issue is a reorganisation within TCGA 1992 s 126. The consequences are as follows:

• the newly issued shares are pooled with the shares in respect of which they were issued (‘the original shares’) to form the new holding
• the new holding and the original shares are treated as the same asset, acquired when the original shares were acquired (TCGA 1992 s 127)

12. The trustees are not regarded as having made any payment for the shares. Because the reorganisation rules apply, the date of acquisition is the date on which the original shares were acquired.

III Enhanced stock dividend regarded as capital but with an adjusting payment to the beneficiary with an interest in possession

13. The trustees may decide that where:

• they have elected to take an enhanced stock dividend in preference to a cash dividend that would have belonged to the beneficiary; and
• the enhanced stock dividend is regarded as capital under trust law

the beneficiary is entitled to some compensation from the trustees for the cash dividend forgone.

14. In these circumstances the tax position of the trustees is as set out in section II above. The payment they make to the beneficiary is an annual payment and tax must be deducted from it at the basic rate in accordance with Taxes Act 1988 s 349(1). No Income Tax is treated as having been paid in respect of the enhanced stock dividend, whether by virtue of a tax credit or otherwise, so the trustees have to account to HMRC for the whole of the basic rate tax deducted from the payment

15. The beneficiary is treated as receiving income taxable under ITTOIA 2005 Pt 5 Ch 7 on which Income Tax at the basic rate has been paid.

16. This treatment applies whether the payment is made:

• out of the proceeds of the disposal of shares comprised in the enhanced stock dividend
• out of other capital of the trust;
• in the form of a proportion of shares comprised in the enhanced stock dividend (Section 410(2) ITTOIA 2005 does not apply in these circumstances because the beneficiary is not beneficially entitled to the stock dividend)

17. Whatever form the payment takes, the trustees are treated as having made an annual payment and the beneficiary as having received a net sum after deduction of Income Tax at the basic rate.

18. For Capital Gains Tax purposes, the treatment described in paras 11, 12 above applies. Where the trustees make the payment to the beneficiary in the form of shares, the transfer constitutes a part-disposal of the new holding.

Scottish interest in possession trusts

19. The same Income Tax treatment applies to Scottish trusts in which a beneficiary has a right to income. Although under Scots law the rights of the income beneficiary are different from those of a beneficiary with an interest in possession in an English trust, for Income Tax purposes the beneficiary of a Scottish trust is treated as having the same rights by virtue of FA 1993 s 118.

20. (This para reflects the changes in FA 1998) For Capital Gains Tax purposes, where the enhanced stock dividend is dealt with as described in section I above (enhanced stock dividend regarded as income), the position of a Scottish trust is different from that of an English trust. Under Scots law the beneficiary is not absolutely entitled to the enhanced stock dividend. However, since ITTOIA 2005 s 410(2) applies to the stock dividend (by virtue of FA 1993 s 118), the trustees are treated as having given ‘the appropriate amount in cash’ (see para 8 above) as consideration for the new holding by virtue of TCGA 1992 s 141. This is not a reorganisation. If the enhanced stock dividend is transferred to the beneficiary the trustees make a disposal to the beneficiary, which by reason of the share identification rules in TCGA 1992 s 106A, would normally be a disposal of the shares acquired as a stock dividend.

Note: the text of this statement was updated in August 2005.