Hike in dividend rates from 2016 make capital reductions (even) more attractive

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.

Capital Reductions

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:

  1. ABC Trading Ltd pays a £1M dividend to the holding company.
  2. The holding company uses these funds to reduce its capital by £1M.
  3. Assuming Entrepreneurs’ Relief conditions apply this £1M will be taxable at 10% (as opposed to rates of up to 30.56% before 6 April 2016 and 38.1% afterwards).


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!




Sign up for our newsletter

Interested in receiving the latest tax planning ideas?

Sign up to Tax Bites – our weekly update offering practical but effective tax saving tips.

Contact Us

You can use this form to request us to give you a call or if you prefer just leave us a message. Please be sure to leave us a contact number or email address for you and we will get back to you as soon as we can.

0161 927 9277


Fairbank House
Ashley Road
WA14 2DP