The last few weeks have been awash with minor and major reforms to taxation in the UK, as part of HMRC’s Tax Update 2026.
While the headlines have been stolen by changes to the way VAT, PAYE and ITSA are paid, for companies, proposals to alter the way that distributions and repayments of capital from companies are taxed could be far wider reaching.
The changes will significantly change the tax treatment of share buybacks, demergers and returns of capital to owners and shareholders, resulting in stricter rules in relation to existing reliefs.
HMRC has stressed that the reforms are not intended to impact shareholders themselves, but when structuring future transactions, they would need to be considered carefully.
Time for change in the current Corporation Tax rules
The rules in relation to distribution have remained almost unchanged since Corporation Tax was introduced in 1965 and HMRC feels that they no longer operate well or reflect more modern approaches.
It is easy to understand why, as there are certain scenarios where almost identical distributions are treated entirely differently, based on the smallest of factors.
In some cases, this has allowed individuals and trusts to take advantage of the more beneficial tax treatment of capital compared to Income Tax thanks to lower rates of tax.
Given the complexity of the rules, HMRC hopes input from shareholders and others will help it to create a more equitable, easy-to-manage system.
What are the key proposals put forward by HMRC?
There are a number of fairly significant changes proposed within the new consultation, which ends on 14 September.
Capital reductions
One of the proposals put forward would prevent the creation and insertion of a holding company above a company making a distribution so that it could increase what HMRC called “good capital” and, thereby, reduce the tax on a reduction of capital.
Instead, share buybacks and other returns of capital will be assigned a “frozen” capital value on the shares for future holding companies at the amount subscribed on the original investment.
This would, therefore, match the Capital Gains Tax deferment of the original base cost, giving the effect as the same outcome as if the original company shares had been sold back without the insertion of the holding company.
HMRC has stated that this should not affect shareholders’ restructuring for legitimate business purposes.
Distributions from non-UK resident companies
Different rules currently apply based on whether the distribution is made from a UK resident company or a non-UK resident company.
For UK resident companies, there is a clearly defined outline for distributions that ensures that extractions of value from continuing companies are charged to income tax.
For non-UK resident companies, the charge to Income Tax is far narrower and limited to dividends which are “not of a capital nature”. This has led to uncertainty and confusion in the past, which the Government hopes to clarify.
Demergers
Capital reduction has been and can be used by companies to perform non-statutory demerges, but this route would be removed by the proposed reforms.
HMRC wants to make companies reliant on the statutory demerger route and is, therefore, looking to amend the existing rule to reduce disputes and allow businesses to act more freely.
In return for the relaxation of the statutory requirements, HMRC has said that it intends to remove the right to apply for automatic appeal by a Tribunal should a statutory demerger clearance be denied.
There are a number of other proposals that affect the treatment of distributions of close companies and changes to the transactions in securities (TIS) legislation as well, which may need to be considered.
What next?
At the moment, the proposals are little more than an early consultation on the future of capital distributions and the final rules may differ significantly and are likely to be included in a future Finance Bill.
Whilst there is no immediate action required, it is important for companies to keep a close eye on this consultation to understand how they may be affected.
In the meantime, if you have any queries about the tax treatment of capital distributions, including demergers or share buybacks, please get in touch with our team.
