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Capital Distributions

Volume 506: debated on Wednesday 24 February 2010

There is, at the moment, considerable uncertainty in relation to the corporation tax treatment of distributions. This uncertainty is causing significant problems to UK business and this statement is intended to establish with certainty a result that will be consistent with established expectations of HMRC practice.

In the Finance Act 2009, the Government introduced a new distribution exemption regime. Since then most income distributions received by UK companies are exempt from corporation tax unless they are linked to tax avoidance. The rules ensure that the UK corporate tax regime remains competitive and represent a significant reduction in the compliance burden faced by UK companies.

As intended, the exemption regime excludes distributions of a capital nature, which are subject to the chargeable gains rules where other exemptions may apply. However, the introduction of the new legislation has prompted HMRC to look more closely at the issue of whether a distribution is of a capital nature.

Before 2005 it was possible to interpret the law as saying that all UK distributions were income in nature unless a specific rule said otherwise—for example, distributions in a winding up. In 2005 a Tax Law Rewrite Act, in clarifying the law, made that view impossible to sustain. Despite this, prevailing practice remained unaltered and so UK distributions have generally been regarded until recently as income in nature and potentially exempt from corporation tax.

In the absence of a rule treating distributions as income, companies in receipt of capital distributions may now face an unexpected tax charge. In some cases, it has become clear that commercial transactions have been put on hold until the tax consequences become clear, with a corresponding effect on the normal business of those companies.

In order to resolve the issue, the Government will introduce legislation in the Finance Bill with a view to restoring previous expectations about the way that distributions are taxed. 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. These new rules will give UK companies the clarity they need to carry on their normal business.