In the first post in this series, Zoe Andrews described HMRC’s consultation on modernising the taxation of distributions and repayments of capital from companies as a possible “fundamental reset”. 

Part of that involves HMRC’s proposals on repayments of capital. While the law in this area (and, in particular, the way it applies in practice for listed companies) is complex, the key takeaway is that HMRC want to put an end to (what they see as) a loophole, under which the amount of “capital” on shares can be increased to enable returns of value in a capital, rather than income, form.

Extracting value

At the heart of the consultation, and many of the rules discussed in it, is that as a principle, HMRC dislike the idea that shareholders can extract what are effectively retained profits, from a company in capital gains form. So they say:

“The government intends to reduce the scope for companies to use the existing rules to extract value from continuing businesses at capital rates.” 

While not stated explicitly, the subtext seems to be that extracting value at capital gains rates should be limited to the amount originally put in as capital, or to very limited situations like where the company is being wound-down (such as a liquidation) or where the specific exemption for unquoted company buybacks in capital form applies (s1033 of the Corporation Tax Act 2010 – itself the subject of another part of the consultation). Otherwise, you’re effectively returning retained profits – and those should, in HMRC’s view, be taxed as dividends.

“Good tax capital”

The idea that what you put in comes back as capital gains sounds simple, but it can quickly become complex. The legislation (spread throughout Part 23 of the Corporation Tax Act 2010) works on a share-by-share basis – so for each particular share, you look at how much capital was put in when that share was originally issued. That might be easy in a small company with a handful of shareholders. But, in a large listed company, where a particular share could have been issued decades ago (or even longer), and subsequently have changed hands many times, it can be near impossible to trace back the history of each particular share.

As a result, HMRC have, for listed companies, generally accepted that the amount put in (the “good tax capital” as we tend to call it) can be averaged across all of the shares. That average figure can then change over time as more shares are issued, or shares are bought back (making tracking it relatively challenging). For each share, that “good tax capital” amount is the amount that can be returned to a shareholder in a capital form – the rest is a distribution. 

New HoldCo Schemes

“Good tax capital” isn’t increased only by new issues of shares for cash – issues of shares for other assets (such as on a share-for-share exchange) also count. The overall “good tax capital” is uplifted by the market value of the assets contributed in exchange for the newly issued shares.

As a result, the easiest way to increase your “good tax capital” has historically been through a New HoldCo Scheme. By inserting a New HoldCo on top of the existing parent company (usually as a tax-neutral share-for-share exchange under s135 of the Taxation of Chargeable Gains Act 1992), shareholders would receive shares in the New HoldCo, and the “good tax capital” on those shares would be equal to the market value of the old parent company shares contributed. The New HoldCo would then be free to return value to shareholders up to that amount in capital gains form.

HMRC have now decided that it is time to put an end to that form of tax planning. 

“Frozen” capital

As this is just a consultation, there is little detail on what exactly HMRC are proposing or how it would work, beyond making some changes to stop New HoldCo schemes from increasing the “good tax capital” position. The consultation says:

            “It is proposed that share buybacks and other returns of capital reflect a ‘frozen’ amount of capital on the shares in any future holding companies at the amount subscribed on the original investment, thereby matching the CGT deferment of the original base cost.”

The reference to CGT base cost is, of course, only relevant in cases where the shares have never changed hands. Where they have changed hands, it’s very likely that the holder’s base cost will be higher than the amount originally subscribed, so there will not be any such “matching”.

But that is far from the biggest uncertainty. It’s unclear, for example, whether HMRC are intending a narrow rule that simply disregards the impact on “good tax capital” of inserting a New HoldCo, or something else. Even with the narrower rule, many questions remain, in particular:

• Will the change only apply to future New HoldCo schemes (once the law comes into force) or will previous New HoldCo schemes be looked-through? Some of these may have happened years or even decades ago.
• Will the current “easement” for listed companies, allowing “good tax capital” to be averaged across all of the shares, continue?
• Will that “easement” also apply to private/unlisted companies? If not, two shareholders who have acquired shares could find themselves in completely different positions.
• What will happen where the New HoldCo is put in place for commercial reasons?
• How will the rules on demergers be amended? New HoldCo Schemes are a typical prelude to a capital reduction demerger (see Ed Milliner’s post on this here). 

Where next?

At the moment, the high-level nature of the consultation proposals leaves us with more questions than answers. This is also difficult area of the law given its reliance, for many corporates, on HMRC guidance. An opportunity to codify the approach for such corporates might well be welcomed, but it remains to be seen whether HMRC will go that far as part of their attempts to close what they likely well see as a “loophole” in the rules.

As Zoe mentioned in her post, the consultation is open until 14 September. Given the complexity and breadth of HMRC’s proposals, it’s likely to be some time after that before there is any further clarity.

See our Distributions Consultation Series 2026 for posts looking at other aspects of the consultation.