When is a dividend not a dividend?

Under the new corporate dividend exemption, dividends received by UK companies from both UK and non-UK companies will generally be free of corporation tax. This is a change from the previous tax regime, where the exemption only applied to dividends paid by UK resident companies.

Unlike the previous UK dividend exemption, the new exemption does not apply to distributions that are "of a capital nature". Instead, a capital distribution received by a corporate shareholder is subject to the capital gains tax regime, and so potentially taxable unless the substantial shareholdings exemption applies.

Since the introduction of the new regime in July 2009, it has become apparent that HMRC is seeking to argue that certain dividends are capital in nature and therefore do not fall within the corporate dividend exemption.

Dividends paid from share premium

In a case heard in November 2009 by the First Tier Tax Tribunal, First Nationwide v The Commissioners for HMRC (where we acted for the taxpayer), HMRC argued that a dividend was capital in nature because it was paid by a Cayman company out of its share premium account. (This is of course not permissible under English company law.)

In a decision released this week, the Tribunal judge dismissed this argument, and concluded that, as following the payment of the dividend the corpus of the shares was still intact, the dividend was income in nature. It is yet to be seen whether HMRC will appeal this decision.

Dividends paid out of distributable reserves created on the cancellation of share capital

HMRC has also been arguing that a dividend paid out of reserves created on the cancellation of capital (which is possible under English company law) is capital in nature in the hands of UK corporate shareholders. HMRC has refused to give clearances that dividends paid of out distributable reserves created in this way fall within the new dividend exemption.

Many listed companies have as a matter of good corporate housekeeping created such distributable reserves as part of other larger transactions. It is also a common technique used to remove dividend blocks within groups. In many cases, it will be impossible to identify what part of the distributable reserves was created in this way, as there will only be a single fungible account to which those reserves were credited.

We do not believe that HMRC’s position is correct as a matter of law, but it is not yet clear whether the decision in First Nationwide might persuade HMRC to change its approach. This is clearly an important area for groups implementing corporate reorganisations, who should seek tax advice before paying affected dividends.

Share redemptions

It also appears that HMRC has changed its practice in relation to the CGT treatment of a UK corporate shareholder on a redemption of shares by a UK company, because it will no longer accept that any element of the amount paid on the redemption is income in nature and therefore excluded from the CGT computation. Again, corporate shareholders involved in such redemptions should take advice.

See also:

Dividends paid from share premium - Mar 2012

First Nationwide - May 2011

First Nationwide and Dividends - Apr 2011

Capital Dividends - An Update - Mar 2010

Capital Dividends - An Update - Feb 2010

Can a dividend by capital in nature? - Feb 2010

Sara Luder (partner)