Tax

On 23 June 2026, HMRC published a consultation on modernising the taxation of distributions and repayments of capital to individuals and trusts. The consultation proposes a significant overhaul of the current UK tax distributions code, with the overall aim of widening the UK income tax net for returns of value from companies and narrowing the scope for capital gains tax structuring. The proposals are not intended to affect corporate shareholders directly but will undoubtedly weigh heavily in any discussions concerning corporate restructurings or returns to shareholders.

It is clear from the consultation that HMRC considers that the different UK tax rules can lead to distortions and asymmetric outcomes for what it regards as substantially similar payments.

What are the proposals?

The key consultation proposals are summarised below.

1. “Frozen” capital on the insertion of new holding companies

Under HMRC’s proposals, inserting a new holding company (“New HoldCo”) above an existing company by way of a share-for-share exchange would no longer result in an uplift in that portion of the new shares in New HoldCo that represent capital to reflect the market value of the shares contributed to New HoldCo as part of the exchange.

Currently, that uplifted capital can be returned to individual shareholders by New HoldCo by way of capital reduction which, broadly, would attract capital gains tax at up to 24 per cent (as opposed to income tax at up to 45 per cent) on an amount up to the market value of the contributed shares. If HMRC’s proposals are implemented, a shareholder’s capital in the shares in New HoldCo would remain ‘frozen’ at the amount subscribed on the original investment in the original company, thereby aligning the capital in New HoldCo with the capital gains tax base cost that was carried over (deferred) on the share-for-share exchange.

This is intended to produce the same tax outcome for a shareholder on a reduction of share capital in New HoldCo as if the shareholder had sold the original company shares back to the original company, without the insertion of New HoldCo.

2. The end of capital reduction demergers

The consultation contemplates removing the capital reduction route for non-statutory demergers.

Currently, companies can effect a tax-neutral demerger by way of: (i) a statutory demerger under Chapter 5, Part 23 of the Corporation Tax Act 2010; (ii) a liquidation demerger under section 110 of the Insolvency Act 1986; or (iii) a capital reduction demerger. Due in part to their flexibility, capital reduction demergers are commonly the preferred method. However, the proposed freezing rule described above would effectively mean the end of capital reduction demergers, which are often structured by way of inserting a New HoldCo above an existing company.

HMRC acknowledges that the statutory demerger route is not currently well-used. Accordingly, to allow businesses to “operate more freely”, HMRC is considering whether to liberalise the conditions, including by:

• removing the requirement for all companies involved to be resident in the UK or in an EU member state;
• extending the scope of the statutory demerger regime to allow investment companies to participate (currently, the company transferring shares or assets as part of the demerger must be a trading company); and
• including demergers that are used to facilitate an onward sale, provided the sale takes place more than five years after the demerger.

Additionally, taxpayers who have a clearance request denied would no longer have an automatic right of appeal to the Tribunal.

3. Alignment of taxation on distributions from UK and non-UK resident companies

HMRC has proposed aligning the tax treatment for distributions to UK resident individual shareholders from non-UK resident companies with that which currently applies to distributions from UK resident companies.

Currently, only dividends from non-UK resident companies which are not of a capital nature are subject to UK income tax (with all other distributions taxed as a capital receipt). Under HMRC’s proposals, the income tax charge would be extended to all dividends and other distributions (including stock dividends).

Whilst the current regime is based on long-established principles for determining whether a payment from a non-UK resident company constitutes a ‘dividend of a capital nature’, derived from Rae v Lazard Investment Co Ltd [1963] 1 WLR 555, HMRC suggests that this can lead to costly and time-consuming uncertainty for taxpayers and to disputes with HMRC (as evidenced by the recent Court of Appeal decision in Beard v HMRC [2025] EWCA Civ 385).

By HMRC’s own admission, however, aligning the treatment of UK and non-UK payments would still require drawing a distinction between a ‘dividend’ (where the entire payment is within the charge to income tax) and ‘other distributions’ (where the amount chargeable to income tax is reduced where the amount represents share capital repaid or new consideration provided). This may still require mapping UK concepts onto non-UK fact patterns, which is likely to cause continuing uncertainty for taxpayers and potential disputes with HMRC.

4. Improper payments: clarifying the order of priority of the distributions code and loans to participators rules

HMRC is exploring proposals to clarify the scope and order of application of the distributions code and loans to participators rules.

The current rules for determining when a taxable distribution is made mean that an amount may be subject to tax as a distribution even where the payment may not be properly made under company law. Where the payment is made by a UK resident “close” company (broadly, controlled by five or fewer participators or by directors who are participators), it will be subject to the loans to participators regime. If there is an obligation on the participator to repay an unlawful dividend, the company may be subject to tax under section 455 of the Corporation Tax Act 2010.

The improper payment may therefore constitute either:

• a distribution chargeable to income tax on the participator, unless the company has recognised the debt and pays, or has paid, the amount due under section 455 within a certain period of time; or
• an unlawful payment potentially not chargeable to income tax, which will result in a charge on the company under section 455.

To ensure that such payments are clearly charged under one set of rules, HMRC is considering establishing a priority rule. The proposed priority rule could work by either:

• clarifying that an obligation to repay an amount received as a result of an unlawful or unintentional distribution will not reduce the amount brought into account for income tax purposes as a distribution; or
• providing that the company will not be liable for the section 455 tax to the extent the distribution has been charged to income tax.

In addition, HMRC is seeking views on whether:

• the current discretionary practice of allowing unintentional distributions to be unwound should be put on a statutory footing; and
• shareholders should be permitted to set off income tax paid on extractions against tax liabilities arising from steps to rectify the improper payment (such as declaring dividends to clear the resulting debt or completing a valid share buyback).

5. Extension of the loans to participators regime to non-UK resident companies

HMRC is considering extending the loans to participators regime to loans or advances made by closely controlled non-UK resident companies.

Currently, the loans to participators rules only bite in respect of loans or advances made by a UK resident close company. The charge (currently imposed at the upper dividend tax rate of 35.75%) is levied on the company and is repayable when the loan is repaid.

HMRC acknowledges that extending the loans to participators regime would present a number of practical difficulties:

• taxpayers would need to assess whether non-UK resident companies would be “close” if they were UK resident (although HMRC notes an equivalent assessment is already required under the “transactions in securities” rules); and
• perhaps more significantly, as a practical matter, the charge would likely need to be levied on the UK resident individual rather than the non-UK resident company. HMRC is considering how and when the charge should be applied (e.g., if the tax should become payable if the loan is outstanding on 31 January after the end of the tax year in which it is made or after some other set period, or if the tax should only become payable if the loan is released or written off).

6. Replacing the “trade benefit test” for capital gains treatment on share buybacks

HMRC intends to replace the ‘trade benefit test’ – applied in determining whether a share buyback from an individual shareholder should be taxed as capital rather than a distribution – with a more mechanical set of requirements.

Amongst the new conditions:

• the departing shareholder must have held a minimum of 5% of the company’s equity for at least two years prior to their departure, during which time they must have also worked for the company (with the period extended to five years where the departing shareholder retains family connections with remaining shareholders and directors);
• the departing shareholder must surrender their entire shareholding and any directorships on their departure (although a shareholder is allowed to dispose of their shareholding in tranches, provided the entire shareholding is disposed of within two years from leaving);
• the company must take reasonable steps to ensure the consideration paid for the shareholding does not exceed market value; and
• relief will be subsequently withdrawn if the departing shareholder becomes a director or shareholder of the company again within five years of leaving.

7. Transactions in securities rules to be amended or replaced

HMRC intends to amend or replace the transactions in securities anti-avoidance rules, which enable HMRC to recharacterise certain transactions as income rather than capital.

The consultation is light on detail. HMRC says the new rules are expected to be “clearer and more principles based” and to act as a backstop if a transaction is not countered by the existing rules; “for example, where the existing legislation is sidestepped on mechanical grounds and where it can be reasonably assumed that [this] is to avoid a charge to income tax”.

Comment

It remains to be seen if, when and how the proposals outlined in the consultation will be implemented into UK law. The consultation is open until 14 September 2026, following which it is hoped that HMRC will take sufficient time to consult relevant stakeholders on any draft legislation before implementation, particularly given the wide-ranging scope and ambition of the proposed changes. In the meantime, groups considering corporate restructurings and individual shareholders (including management in a private equity context) will face a period of further uncertainty.