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HMRC internal manual

Business Income Manual

Meaning of trade: mutual trading and members clubs: distributions on winding-up: taxable on first principles or statute

S104 Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005), S101 Corporation Tax Act 2009 (CTA 2009)

The situation where you may be able to tax a distribution on first principles is discussed briefly at BIM24555.

Traders who are members of a mutual entity may make payments to that entity. These payments are allowable if they are not capital (BIM35000) and are incurred wholly and exclusively for the purposes of the trade (BIM42100).

Any payments received by a trader from the entity are treated, on first principles, as a receipt of the recipient’s trade to the extent that they constitute a return of contributions made.

The following distributions out of the mutual surplus from a mutual business are taxable as receipts from the recipient’s trade without recourse to legislation:

  • from a corporate mutual concern (other than in a dissolution or winding up), or
  • from a non-corporate concern in all circumstances.

Anything that is not a return of contributions must have arisen from the mutual entity’s non-mutual operations and should therefore have been taxed in the mutual’s hands. Hence S1070 Corporation Tax Act 2010 applies the distributions legislation to such sums.

S104 ITTOIA 2005 and S101 CTA 2009 act to bring into charge to Corporation Tax or Income Tax any sums received on winding-up or dissolution from a body corporate carrying on a business that is, or is in part, a mutual trade. Such a distribution is treated as a receipt in calculating the profits of the recipient’s trade. If the recipient has ceased trading before receiving the distribution, it is treated as a post cessation receipt of the trade.

The legislation is structured to ensure that the charge cannot be avoided by:

  • arranging for assets to be distributed as part of a wider scheme of reconstruction or amalgamation, or
  • transferring or surrendering the right to receive a distribution.

The legislation only applies if a deduction has previously been allowed for a contribution to the body corporate. This is a simple qualitative test. The charge is not linked to the extent of any previous claimed deduction.

For the purposes of the charge, trade does not include any trade where all the profits have been chargeable to tax (ie non-mutual trade).

The assets out of which the distribution is made must themselves represent profits of the body corporate’s mutual business. This means that the charge does not apply to distributions that:

  • represent the return of capital,
  • represent capital gains, or
  • are made out of profits which have been chargeable to tax.