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Company distributions: capital or income?

Advisers need to be aware of important changes on the horizon, as Rebecca Cave explains.

Many small companies accumulate cash for a variety of reasons. If the shareholders don’t need the funds, there is no reason to pay out profits and incur tax charges.

From 6 April 2016 the new dividend tax rates, 7.5%, 32.5% and 38.1% (for details see the briefing on page 14), will make it even less attractive to pay out funds which aren’t needed for personal expenditure or investment. But the dividend tax rates are not the only proposed changes affecting company distributions.

In general, companies continue to accumulate surplus funds until one of the following occurs:

  • sale of the company to a third party;
  • purchase by the company of some of its own shares
  • repayment of some share capital; or
  • liquidation.

In all these situations the shareholder can receive a payment which is taxed as a capital gain at CGT rates of 18%, 28% or 10% (when entrepreneurs’ relief (ER) applies), rather than as income. Note that if the distribution is made on an informal winding-up it will be taxed as income where the total exceeds £25,000 (s1030A, Corporation Tax Act 2010). Also, ER won’t necessarily apply to a cash-heavy company on sale or winding-up.

The government believes that shareholders achieve a “tax advantage” by being taxed on a gain rather than on income, so is consulting on changes to the tax treatment of company distributions. A policy paper, Corporation Tax, Income Tax and Capital Gains Tax: company distributions, and draft legislation for Finance Bill 2016 were published on 9 December 2015.

This is an extract from an article in the February 2016 edition of TAXline, the magazine of the Tax Faculty.

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