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Capital reduction

Income treatment - base cost?

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Client company wants to carry out a capital reduction by way of creating distributable reserves.

I’m aware that with a ‘one-stage’ reduction a part-disposal calculation is carried out to attribute base cost when calculating the capital gain.

But with an income distribution what happens to the tax base cost of the remaining shares? My understanding is that the distribution of the newly created reserves is simply treated as an income distribution in full. So do the remaining shares carry forward the full base cost or does it get reduced somehow?

Thanks

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By johnhemming
22nd Aug 2019 19:43

I am not an accountant, but I would expect the base cost for CGT purposes to remain the same as nothing is happening to the shareholders. What is happening is a capital reduction and I don't see how that can affect the tax position of a shareholder and then separately an income distribution which one presumes is treated as dividend income.

It does, of course, raise the question as to why the capital return is done by way of an income distribution rather than a partial buy back.

I did, however, spend some time studying the issue of capital reductions when Aviva threatened their pref holders with a buy back at par.

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Replying to johnhemming:
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By Accountant A
23rd Aug 2019 12:35

Quote:

I am not an accountant,

The site has reached its illogical conclusion. It's now a website for accountants where non-accountants ask questions with replies from non-accountants.

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Replying to Accountant A:
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By Tax Dragon
23rd Aug 2019 12:40

I thought John's comment a refreshing change.

Anyone can call themselves an accountant (there're threads about that). That's probably where any semblance of logic parts company with the rails.

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Replying to Accountant A:
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By johnhemming
23rd Aug 2019 14:55

Just because someone is anonymous does not mean they are not an accountant.

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Psycho
By Wilson Philips
22nd Aug 2019 20:25

Instinctively I would say that since the shares in question no longer exist then the corresponding base cost should also be extinguished. Notwithstanding the income treatment of the distribution the shares have in fact been disposed of. I don’t see why the same part-disposal method should not be used to establish the base cost of the remaining shares.

But all of the above is said without any authority.

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Replying to Wilson Philips:
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By johnhemming
22nd Aug 2019 20:29

I am confused as to why a capital reduction means a reduction in the number of shares. It will reduce the amount of capital, but I would expect the number of shares to remain the same.

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Replying to johnhemming:
Psycho
By Wilson Philips
22nd Aug 2019 20:49

Well, if you have 100 issued £1 shares and, without redesignating shares, reduce share capital to £50 what would you say you have at that point?

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Replying to Wilson Philips:
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By johnhemming
23rd Aug 2019 07:10

There are still 100 shares issued for which people (or other legal entities) paid £1 each.

There is no reason why an entry in the books of the limited company has an effect on the above fact.

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Replying to johnhemming:
Psycho
By Wilson Philips
23rd Aug 2019 07:25

Are there? You do realise, I hope, that there is more than one way of effecting the capital reduction?

If share capital has been reduced from £100 to £50 and the nominal value has not been changed, please explain how there can still be 100 £1 shares in issue.

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Replying to Wilson Philips:
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By johnhemming
23rd Aug 2019 10:14

I am making a distinction between a capital reduction and capital return (which is a valid distinction).

The value of the share remains 1/100th of the company after the capital reduction.

Once the dividend has been distributed there is less money in the company, but the shares still originally cost £1.

Even if people paid a premium for the shares when issued all they paid was the nominal value and the premium.

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Replying to johnhemming:
Psycho
By Wilson Philips
23rd Aug 2019 11:49

You seem to be applying a very narrow interpretation of 'capital reduction' to a reduction in the nominal value of the shares, as opposed to the more general interpretation - used by accountants and tax advisers - referring to a reduction in the amount of the company's issued share capital, which can be achieved by, inter alia, a reduction in nominal value or a cancellation of shares.

In which case we're both right.

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Replying to Wilson Philips:
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By johnhemming
23rd Aug 2019 12:19

It is a question of precision of language. AIUI the companies law protections are to protect creditors to ensure that there is capital in the company to pay the creditors.

Hence to make a payment in some way that reduces the capital in the company some form of process needs to be gone through to ensure that sufficient capital remains to protect creditors.

It remains my view that if the shareholders are not getting any cash for their shares as part of partial disposal or selling the shares back to the company then there is no capital transaction. Any dividend would, of course, be an income transaction.

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Replying to johnhemming:
Psycho
By Wilson Philips
23rd Aug 2019 12:35

Quote:

Hence to make a payment in some way that reduces the capital in the company some form of process needs to be gone through to ensure that sufficient capital remains to protect creditors.


I think perhaps that you need to read up on capital reductions supported by solvency statements
Quote:

It remains my view that if the shareholders are not getting any cash for their shares as part of partial disposal or selling the shares back to the company then there is no capital transaction.


I wouldn't disagree, but since the purpose of a capital reduction is invariably to make a payment to the shareholders ...
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Replying to Wilson Philips:
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By johnhemming
23rd Aug 2019 14:48

Quote:
I think perhaps that you need to read up on capital reductions supported by solvency statements

Solvency statements are, of course, a process as is going to court. I spent 10 years sitting on a committee that considered procedure which probably makes me a bit more picky as a result.

I do think, however, that it is worth being precise as to the use of language and to distinguish between a capital reduction and a return of capital much that both may occur at the same time.

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By Ruddles
23rd Aug 2019 09:09

The discussion does raise one question. I have read that if a capital reduction is effected by way of a cancellation of shares then you normally have a capital gain (unless, as in some cases, a distributable reserve is created instead). However, the same commentary suggests that if instead of cancellation of shares you reduce the nominal value then since there is no disposal there can be no CGT charge. Sounds too good to be true:

Shareholders, many years ago, exchanged say 100 £1 shares for shares in new holding co (800,000 £1 shares issued, being the value of the trading co at the time.) Base cost of new shares continues to be £100. But what if nominal value is now reduced to 0.1p, with £799,200 being returned to shareholders? No CGT (if the commentary is correct) but presumably TiS could kick in (although at the time of the share-for-share there was no obvious intention to extract cash in this manner)?

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Replying to Ruddles:
By Duggimon
23rd Aug 2019 09:33

Presumably the answer is no, or you'd have posted it, but do you have a link to the commentary?

I'd be interested to know just how that could work. As you say, TiS and GAAR would likely stop anyone using it to immediately extract funds tax free, but as a purely academic point I'd like to read more.

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Replying to Duggimon:
By Ruddles
23rd Aug 2019 09:50
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Replying to Ruddles:
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By Tax Dragon
23rd Aug 2019 11:01

There doesn't have to be a (real) disposal for there to be a disposal for CGT though, does there? I don't know enough about company law to know whether the £799,200 would be a (capital) dividend. If so, s122 seems to be in point. If not, might it come under s22? (assuming no TiS etc application, of course)

Edit: I might not need to learn company law... just how to read tax law better. The terms are defined there, d'oh!

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Replying to Tax Dragon:
By Ruddles
23rd Aug 2019 11:42

I agree with you. I'm just interested in the suggestion that there would be no tax implications of a reduction in nominal value.

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Replying to Ruddles:
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By Tax Dragon
23rd Aug 2019 12:06

The article is quite brief.

I'm not sure it's suggesting that a payment to the shareholders would have no tax implications.

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Replying to Tax Dragon:
By Ruddles
23rd Aug 2019 12:12

"Where the reduction is achieved by a reduction in the nominal value or unpaid amounts this is not a disposal of an asset so has no tax implication"

seems pretty unambiguous to me ;¬)

(Especially when read in context of the rest of that paragraph)

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Replying to Ruddles:
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By Tax Dragon
23rd Aug 2019 14:33

The rest of the paragraph is presumably based on the notion that, as a cancellation of shares is a disposal and as the company and the shareholder in point may be connected (or maybe that the disposal is not at arm's length), then MV rules might apply.

Let me just say: I won't be relying on the paragraph in question as the basis of giving tax advice.

(And to some extent I am echoing John's point about distinguishing between two steps, even if 19 times from 20 left does follow right.)

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Replying to Tax Dragon:
By Ruddles
23rd Aug 2019 14:58

Fair enough, and I take John's point about the precise use of language.

That said, I think that most accountants and tax advisers use the term "capital reduction" to mean a particular thing - namely, the reduction of the amount of the company's issued share capital. And I don't think it is necessary to distinguish between two steps, given that most capital reductions involve a single step (to avoid the creation of distributable reserves).

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Replying to Ruddles:
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By Tax Dragon
23rd Aug 2019 15:58

I just tried moving left and right together.

I found myself jumping up and down.

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