HMRC’s consultation on modernizing the taxation of distributions ends today.

The proposals contained in that paper affect areas of tax law that are well-established and form the basis of many corporate and investment structures.

Two proposals stand out:

• The first is the proposal for a freeze on the level of capital treated as paid up on shares issued as part of a share exchange or reconstruction.
• The second is the extension of Part 23 CTA 2010 rules – the rules which apply to determine which payments are treated as income distributions for corporation tax purposes and distributions from UK resident companies for income tax purposes – to distributions received by UK income taxpayers from non-UK resident companies.

Both of these proposals have potentially broad implications. As the consultation paper acknowledges, the first could materially affect the ability of UK-based groups to undertake various forms of demerger and corporate restructuring. The second could undermine the basis of many investment and private capital structures.

The primary targets – if the examples that are given in the consultation paper are to be believed – are, however, much narrower. It would appear that the main concern that has given rise to these proposals is the ability of individual participators in closely-held companies to receive amounts that would otherwise be distributable by way of dividend in a capital form whether that be on a repayment of capital by a UK resident close company following a share exchange, or the return of funds on a share-buyback or through a dividend of a dividend of a capital nature from a non-UK resident but closely-held company.

HMRC’s desire to address these issues is understandable, but they could be addressed by more narrowly targeted measures - for example, by amendments to the existing transactions in securities rules- without the potential collateral damage.

Furthermore, the Part 23 rules and other aspects of the UK tax treatment of distributions are (loosely) based on UK company law. They reflect its concept of distributable reserves and the principle of maintenance of capital. Just last week, the Department of Business, Innovation, Science and Trade published another consultation paper on corporate reporting. That paper – entitled “Modernising Corporate Reporting to support long-term economic growth” – calls for comments on a suggestion that the existing company law rules on distributions and maintenance of capital might be replaced by a solvency-based regime. That would be a radical reform. It should prompt a reassessment of the UK tax rules applicable to distributions more generally. It does also suggest that now is not the time for material, wide-ranging, changes to the long-established structure of UK tax regime. It may be appropriate to defer any significant changes to the tax regime governing the taxation of distributions so that they can be considered in parallel with the company law proposals and to limit any immediate changes to the areas of more specific concern.

Authored by Ashley Greenbank.