Broadly, dividend stripping is the practice of paying dividends out of a company to decrease (or ‘strip out’) value before the company is sold. The idea is that the dividends which are paid out are usually not taxable if received by a corporate shareholder, although the capital gain on a disposal often would be. This sounds like a good idea but there are various tax rules to be aware of. Most notably, these are the rules on ‘depreciatory transactions’ and ‘value shifting’.
Depreciatory transactions rules
The main point to understand is that these rules have a limited bite. All that they can do is limit losses which have only occurred because of a ‘dividend strip’ and only then if the disposer owns 10% of the shares. There are also provisions to ensure that this legislation still bites even if shares are transferred intra-group using nil gain/nil loss provisions.
Therefore if you are looking at a gain in respect of a share disposal then you can forget about this legislation – but value shifting legislation may apply (below).
HMRC are generally happy that this legislation will not apply to dividends which are paid out of post-acquisition reserves. Presumably this is on the basis that the thing that they find offensive is where value is stripped out that was inherent in the acquisition cost of the shares (in respect of which a deduction will be taken in the capital gains tax computation).
Value shifting rules
In contrast to the rules above, these rules can apply to create a gain. They can apply when the value of an asset has been reduced prior to its disposal and a tax-free benefit is conferred on the person making the disposal or a connected person. In these cases HMRC can apply a counteraction notice to adjust the consideration (and so a gain can arise). The key tests that need to be met before they can counteract are as follows:
(1)arrangements have been made whereby the value of those shares or securities, or of any asset which, at the time of the disposal, was owned by a company in the same group as the disposing company, is materially reduced;
(2)the main purpose, or one of the main purposes of the arrangements is to avoid a liability to corporation tax in respect of chargeable gains for the disposing company or any other person; and
(3)the arrangements do not consist solely of the making of an exempt distribution.
The things to take away from this is:
1. There is a motive test which means that the position will sometimes be defendable even when tax savings have been achieved.
2. Furthermore, in the context of ‘dividend stripping’ working out what constitutes ‘an exempt distribution’ is important. This provision is meant to help shareholders because it is likely that many scenarios will involve arrangements that ‘consist solely of making an exempt distribution’. Here, as long as the profits out of which the dividend is being paid are ‘normal’ and have been subject to tax, then these rules should not apply.
Forbes Dawson view
From the above, it would be fair for us to conclude that generally ‘dividend stripping’ is perfectly OK and should not be subject to tax anti-avoidance legislation. Apart from when prearranged tax avoidance schemes have been undertaken, the main impact of these rules will be to limit capital losses. Advice should always be taken in these kind of transactions because often the bite of this legislation is not as severe as it first appears.
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