The Finance Act 2009 saw a radical overhaul of the UK’s taxation of company dividends and distributions regime, and the Finance Bill clauses published in December 2011 continue these changes. The new clauses deal with the tax consequences of distributions arising from intra-group transfers of assets, and are primarily relevant to dividends and distributions in specie, and other intra-group transfers of assets below market value or book value. The new clauses should, if and when enacted, remove some of the uncertainty which surrounds the tax treatment of distributions in specie; however, there is more work to be done.
The UK’s taxation of company dividends and distributions has been in a state of flux ever since the radical overhaul of the regime, which took place in FA 2009. One of the aims of that reform – motivated in no small part by a desire to protect the UK regime from further challenges under EU law – was to place dividends and distributions received by UK companies from companies resident outside the UK on the same footing as those received from UK companies.
The reform has cast doubt over the tax treatment of many common transactions. It has subjected a once fairly settled piece of legislation, the interpretation of which was broadly accepted and understood by revenue authorities, taxpayers and their advisers alike, to a period of regular change as the government has sought to deal with some of the unforeseen consequences of the changes that were made.
The Finance Bill clauses, which were published in December 2011, contain the latest instalment in that process. The new clauses deal with tax consequences of distributions arising from intragroup transfers of assets. These are primarily relevant to dividends and distributions in specie, and other intragroup transfers of assets at undervalue. While distributions in specie might seem a fairly narrow topic, it is remarkable how often these transactions occur in group reorganisations and reconstructions.
It is perhaps best to begin by defining what we mean by a distribution or dividend in specie. For a company incorporated in England and Wales, there are broadly two types of transaction which are covered by this description.
The first is where the company declares a dividend in a specified cash amount and that dividend is then satisfied by the transfer of the relevant asset to the shareholders. This is the type of transaction contemplated by Article 34 of the Model Articles (set out in the Companies (Model Articles) Regulations, SI 2008/3229, Sch 1, which is the equivalent of the old Article 105 of Table A to the Companies Act 1985). The amount of the cash dividend may be equal to either the market value of the asset which is being distributed or, perhaps more commonly, the book value of that asset. The consequences of this choice in tax terms are discussed below.
The second is where the company simply distributes the asset in specie to members without first declaring a dividend of a specified cash amount.
For companies that are incorporated in England and Wales, distributions that are not paid in cash are still distributions for Companies Act purposes and accordingly can only be made if there are sufficient profits available for the purpose. In order to make the distribution a company will have to have distributable reserves at least equal to the 'amount' of the distribution in specie.
The Companies Act 2006 provides some assistance in this respect.
Companies Act 2006 s 845 sets out the basis for calculating the amount of distributable profits which the company needs to have in order to make a distribution consisting of or including a non-cash asset. Where the distributing company is not receiving any consideration for the transfer of the non-cash asset, those principles can be summarized as follows.
Under Companies Act 2006 s 846, where a company makes a distribution consisting of the transfer or disposal of a non-cash asset, the distribution is deemed to realise any unrealised profit shown in the accounts in respect of the book value of that asset (eg, because the asset has previously been re-valued). That unrealised profit is treated as a realised profit for the purposes of determining the lawfulness of the distribution and whether or not the asset can be distributed in kind. So the determination of whether or not a distribution in specie can be made is effectively the same as if the asset had not been re-valued and the distribution was made in reliance upon s 845.
These different ways of distributing assets to shareholders broadly achieve the same economic result and it might therefore be reasonable to expect them to have broadly the same tax consequences. That has not been the case in the past.
Under the current rules, if a UK resident company declares a dividend in a cash amount equal to the market value of the relevant asset and transfers that asset to its shareholders in satisfaction of the dividend, then the full cash amount is a ‘dividend’ within CTA 2010 s 1000(1) para A and so a ‘distribution’ for the purposes of CTA 2010 Part 23.
Where that distribution is received by another UK resident company, the recipient company is, in principle, subject to corporation tax on income on that distribution under CTA 2009 s 931A. However, a UK resident corporate shareholder will be exempt from tax on the dividend in specie provided that the distribution falls within an exempt class in CTA 2009 Part 9A. In the context of an intragroup dividend in specie, the distribution will often fall within the exempt class for distributions from controlled companies (in CTA 2009 s 931E).
If the entire amount of the dividend in specie is subject to corporation tax on income under s 931A, it cannot be taxed as a capital distribution, even if it is exempt because it falls within an exempt class. (This is now clear from TCGA 1992 s 122(6)).
The treatment of this type of dividend in specie is therefore relatively clear. But it does depend upon the entire amount of the distribution being treated as a 'dividend' within para A. The form of the transaction as a dividend has been regarded by most advisers as determinative of this point. Some doubt was cast on that approach by arguments raised by HMRC in the First Nationwide v HMRC [2011] STC 1540, which might suggest that the meaning of ‘dividend’ in paragraph A is limited to distribution of commercial profit. That uncertainty may be resolved in the relatively near future. But in any event, HMRC guidance (in HMRC Capital Gains Manual at para CG45314) suggests that HMRC accepts this analysis.
If a distribution in specie takes the form of a company declaring a dividend in a cash amount equal to the book value of the relevant asset, which it then satisfies by transferring the asset to the shareholders, the specified amount of the dividend should again be regarded as a 'dividend' within s 1000(1) para A. For UK resident corporate shareholders, that amount will either be subject to UK corporation tax on income under CTA 2009 s 931A or exempt if it falls within an exempt class in CTA 2009 Part 9A.
That leaves the question of the treatment of the remainder of the value of the asset. This element is potentially a distribution either within para B (other distributions in respect of shares) or para G (transfers of assets or liabilities). Under the existing law, either or both of para B or para G might apply (see the decision of the Special Commissioners in Noved Investment Co v HMRC [2006] STC (SCD) 120). The effect is that in the context of most distributions in specie the full amount of the value of the asset will, in principle, be treated as a distribution for the purposes of CTA 2010 Part 23.
That will not however, be the case for many distributions made to UK resident corporate shareholders. Sections 1002 and 1021 contain exceptions, in similar terms, from para B and para G for transfers of assets made by the distributing company to another UK resident company which is either a member of the same group or which is not under common control. These provisions, which are essentially relics of the old advance corporation tax regime, can result in much of the value of many intragroup distributions in specie falling outside the definition of a distribution in CTA 2010 Part 23.
Does this mean that the excess value can treated as a capital distribution within TCGA 1992 s 122? The definition of capital distribution in s 122 is broad: it refers to ‘any distribution from a company’. The only exception is for distributions which are subject to income tax or corporation tax on income (or would be subject to corporation tax on income but for falling within an exempt class). So you might take the view that, if the excess value cannot be a distribution for the purposes of CTA 2010 Part 23 (and so cannot benefit from the exclusion in s 122(6) for distributions that have been subject to tax on income or exempt from tax under Part 9A), it must then be a capital distribution within s 122.
On this issue, HMRC guidance (also contained in CG45314) confirms that distribution in specie which takes the form of a dividend which is satisfied by the transfer of an asset will be ‘tax neutral’. Even if the excess of the market value over the book value is not a distribution (as a result of the operation of s 1002 or s 1021), that amount is not then treated as a capital distribution.
The explanation in the Manual is given by reference to distributions within para G, but it seems reasonable to expect the same practice to apply to distributions within para B given that neither one of para B nor para G has priority over the other.)
The basis for this treatment is not entirely clear but would appear to be that the excess value is not distributed ‘in respect of shares’. The practice is certainly well-established: a version of CG45314 has been in the Manual for many years.
The treatment in CG45314 is not extended to a distribution in specie which comprises the simple distribution of an asset to shareholders without first declaring a dividend. This presumably on the basis that this distinction is ‘in respect of shares’.
As a result, in a case where the transaction cannot be a distribution within Part 23 (because it is excluded by s 1002 or s 1021), that amount of the value may be a capital distribution within TCGA 1992 s 122.
In cases where the substantial shareholding exemption or another relief applies, this might not be a particular problem, but in a case where the substantial shareholding exemption does not apply, the distribution may be taxed as a capital gain. The rather odd result is that distributions in specie between UK resident companies may be taxed when those which are received from non-UK resident companies are largely exempt.
The Finance Bill clauses make two main changes.
The repeal of s 1002 and s 1021 should mean that, for the most part, distributions in specie received by UK resident companies which are not dividends (within para A) will fall within para B and so either be taxed as income or perhaps more commonly be exempt from corporation tax where they fall within an exempt class in CTA 2009 Part 9A. Such distributions will not then be capital distributions within TCGA 1992 s 122.
This should put distributions received by UK companies from other UK resident companies on the same footing as distributions received from non-UK resident companies and remove the distinction in tax treatment between distributions in specie which take the form of a transfer of an asset in satisfaction of a dividend and those which involve a simple distribution of the asset, which is discussed above.
The priority which is to be given to para B will have most effect in cases where a distribution of a non-cash asset might to some extent be regarded as a repayment of capital on shares.
In those cases, that element of the distribution will no longer be capable of falling within para G even if all of the relevant conditions are met. Such distributions are then potentially taxed as capital distributions unless a relevant relief is available.
This change in priority is unlikely to have a material effect on distributions between UK companies. This is particularly the case given that distributions paid out of reserves created on a prior reduction of capital are not treated as a repayment of capital (by s 1027A) for corporation tax purposes. For distributions in specie made to income taxpayers the assistance of s 1027A is not available. The other area of concern relates to distributions from non-UK companies where the question as to what amounts to the capital of the company may be more difficult to determine. But both of these points represent wider difficulties inherent in the operation of the current distributions rules.
The new clauses should, if and when enacted, remove some of the uncertainty which surrounds the tax treatment of distributions in specie. This is a good result. But there is more work to be done to produce a workable code for the taxation of dividends and distributions, in particular in the areas of the application of the rules to distributions from non-UK companies and the treatment of dividends and distributions received by income taxpayers following a reduction of capital. Some these issues cannot be easily resolved until there is a final resolution of the arguments in the First Nationwide case.
Ashley Greenbank, Head of Corporate Tax Group, Macfarlanes LLP
