There has always been uncertainty as to the tax treatment of dividends which are paid out of newly distributable reserves as a result of a capital reduction. A capital reduction is now made easier following the enactment of the Companies Act 2006, section 641.

The general view is that that tax treatment should follow the purpose of any distribution made however Part 9A of CTA 2009 exempts distributions made to corporate shareholders and Part 23 of CTA 2009 specifies that only distributions of share capital in respect of a qualifying repurchase of own shares or a liquidation qualify as capital. 

HMRC expressed concerns that the distribution exemption could be used for company avoidance purposes to mitigate capital gains tax on company share disposals that do not qualify for the Substantial Shareholding Exemption (SSE).

The Financial Secretary to the Treasury has just published a Written Ministerial Statement (WMS) confirming that legislation will be introduced in the 2010 (No 3) Finance Bill to restore previous expectations about the way that distributions are taxed. The WMS also says that the changes will apply retrospectively where appropriate and will be subject to an opt out to ensure that UK retrospective application of the new legislation does not increase tax liabilities.

The new measures will relate only to company to company distributions, and will have no bearing on income tax. For income tax the tax treatment in the hands of the shareholder will depend on the nature of transactions, key areas affected are:

Extra Statutory Concession (ESC) C16 

Purchase of own shares – out of capital

A Capital reduction to creating distributable reserves.

Additionally there may be transactions in securities issues to consider and this may mean that tax clearance will be required to secure capital treatment.

If you are considering using a capital reduction and need assistance please contact our Virtual Tax Partner helpline.