Currently the maximum effective tax rate on dividends is 30.56% but this rate will rise to 38.1% from 6 April 2016.
Given that capital gains tax rates are not set to rise (28% at higher rates and 10% with Entrepreneurs’ Relief) this means that there is even more motivation to extract company funds as capital where possible.
For companies with sufficient capital, rather than taking a highly taxed dividend, shareholders should consider taking cash out as a capital reduction which would be subject to lower capital gains tax rates.
Not all companies will have sufficient capital to make this viable. For example many large companies only have low share capital of about £100. However, in cases where a holding company has been inserted on top of a trading company by way of a share for share exchange the share capital will be much bigger. Typically the share capital (and share premium) will in these circumstances equate to the value of the trading company at the time of the transaction.
In 2010 a holding company was placed above ABC Trading Ltd by way of a share for share exchange. The company was worth £3M at this point in time and therefore £3M of share capital was issued by the holding company. In 2015 the shareholders are considering taking out a £1M dividend. They want to do this as they are mindful of the significant increase in tax rates from 6 April 2016. Pursuant to advice the following takes place instead:
The only weapon that HMRC has to attack this is ‘Transactions in Securities’ legislation whereby they could seek to subject the proceeds from the reduction to income tax rather than capital gains tax. Although we could not discount the possibility of a HMRC attack along these lines, our view is that this legislation does not apply to most forms of capital reduction. Furthermore (unusually) the onus is on HMRC rather than the taxpayer to enforce these rules.
Even in a worst case scenario (whereby HMRC were successful in an attack) the consequences could arguably be better than doing nothing for reductions carried out before 6 April 2016. This is because any income tax would be chargeable by reference to current rather than future income tax rates.
Shareholders owning companies with significant share capital should be considering (in the context of rising dividend rates) whether a capital reduction is right for them. With a fair wing this could result in a saving of up to 28.1% in extraction costs!
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