Significant changes proposed to the taxation of distributions

The government published the consultation document Modernising the taxation of distributions and repayments of capital from companies as part of the Tax Update 2026.

ICAEW’s Tax Faculty has provided a summary of the key proposals below and will be responding to the consultation.

Reduction or return of share capital

Perceived issue(s): The government believes that shareholders are using arrangements such as capital reductions to extract profits accrued within a company in a form that is chargeable to capital gains tax (CGT), rather than income tax. The consultation document includes the example of John who is able to extract funds from his company – “which has not stopped trading and which he still owns in the same proportion as before” – in a form that is chargeable to CGT, giving him an increased after-tax receipt compared to taking a dividend.

Solution(s) proposed: The government proposes that share buybacks and other returns of capital will reflect a “frozen” amount of capital on the shares in any future holding companies at the amount subscribed on the original investment, matching the CGT deferment of the original base cost. Applying the change to John’s situation (above), all of the value (apart from the amount paid to subscribe for his original shareholding) would be extracted as a distribution, removing the tax advantage.

Demergers

Perceived issue(s): The proposal made for share buybacks and other returns of capital (immediately above) would remove the capital reduction route used by corporate businesses to carry out capital reduction demergers, increasing reliance on the statutory route (chapter 5, Part 23, Corporation Tax Act (CTA) 2010), which is “not currently well-used”.

Solution(s) proposed: The government intends to change a number of the conditions relating to demergers. The proposed changes are “loosely based on the broad principles that HMRC currently applies when considering whether to grant clearances”, and in some instances will “go further than existing practice and will allow the relief to be used in a wider variety of circumstances”.

The tax treatment of distributions from non-UK resident companies

Perceived issue(s): Different rules apply for taxing distributions depending on whether the distribution is made by a UK-resident or non-UK resident company. The government says that, as distributions from non-UK resident companies can benefit from a more favourable tax treatment, “this can incentivise businesses to utilise non-UK resident companies rather than UK resident companies and to extract money in forms other than dividends”.

Solution(s) proposed: The government is interested in exploring options to align the tax treatment of distributions from UK-resident and non-UK resident companies by extending the income tax charge to A, B, G and H distributions (including stock dividends), as defined under s1000(1), CTA 2010, to distributions made by non-UK resident companies. The government may also extend the income tax charge to C, D, E and F distributions, including the issue of redeemable bonus shares or bonus securities and interest or other payments on debt with equity characteristics.

The loans to participators rules and distributions

Perceived issue(s): Issues can arise where the making of a distribution by a close company to a participator is later found to be an unlawful dividend. In this case, the funds are repayable to the company by the participator, giving rise to a tax charge on the company under the loans to participators regime (Part 10, CTA 2010). The government says that uncertainty over the correct tax treatment to apply at the time, and timing issues, can lead to unfair outcomes and “costly disputes and litigation”.

Solution(s) proposed: The government is considering the following three options to provide greater clarity in this area:

• establishing a priority rule, to “provide certainty” and “ensure that tax is due at the time the value is extracted from the company;
• legislating the current discretionary practice of allowing the unwinding of unintentional distributions; and
• enabling income tax paid on extractions to be offset against liabilities incurred on rectifying the improper extraction of funds.

The loans to participators rules and non-UK resident companies

Perceived issue(s): The loans to participators regime does not apply to loans or advances made by closely controlled non-UK resident companies. The government says this can mean “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”.

Solution(s) proposed: The government is considering introducing a new tax regime applying to loans or advances from companies that would be close if they were UK resident. The charge to tax on a loan or advance, and any relief due when the loan or advance is repaid, would be on the UK resident person and paid through their tax return.

The purchase of own shares rules

Perceived issue(s): The purchase of own shares rules (s1033-1053, CTA 2010) enable a company to buy back its own shares without making a taxable distribution. However, the rules incorporate “a subjective ‘trade benefit test’ which … is a significant source of dispute between customers and HMRC”.

Solution(s) proposed: The trade benefit test will be replaced with “a more mechanical set of requirements” in order “to improve clarity”. The proposed requirements include that “the departing shareholder has to surrender their entire shareholding and any directorships on their departure”. The intention behind these provisions is to ensure that the departing shareholder had a significant interest in the company prior to the departure and no longer holds an interest for sentimental reasons.

The transactions in securities rules

Perceived issue(s): The transactions in securities (TIS) legislation (Part 15, CTA 2010) has been in existence since the 1960s (in its original form) and is intended to counter avoidance and ensure that extractions of value are taxed as income. However, the “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”, says the government.

Solution(s) proposed: The government intends to amend or replace the TIS rules with an updated anti-avoidance regime which better reflects contemporary business structures and provides “a more flexible and modern framework in which to tackle avoidance”. The government expects the new rules “to be clearer and more principles based”, tackling “scenarios where a taxpayer is party to arrangements that enables them to extract value from a company and avoid paying tax”.