We are seeing companies distribute funds by way of a dividend when they should be considering capital reductions.
A dividend is taxable at an effective rate of 30.56% (for high earners) whereas a capital reduction can be taxable at a 10% capital gains tax rate if Entrepreneurs’ Relief applies.
There needs to be sufficient share capital to make a payment through a capital reduction and for these purposes share capital can include share premium account. This will often be the case after a holding company has been inserted over an existing company. This is because the holding company is treated as issuing share capital equivalent to the value of the existing company.
Due to fairly recent changes in the Companies Act capital reductions are relatively easy to achieve.
This kind of cash extraction should not be undertaken without having due regard to transactions in securities legislation. If HMRC are able to invoke this then the capital reduction would be taxable at dividend rates. However the onus is on HMRC to invoke this legislation and arguably a capital reduction is not a transaction in securities.
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