Wednesday, March 31, 2010



Stephen Timms made a very interesting written statement to Parliament at the end of February. He told them (as has since been confirmed in the Budget) that the government would introduce legislation in the Finance Bill to clarify that for corporation tax purposes all UK distributions are income in nature unless a specific rule says otherwise. That is good news. However the interesting bit is the background.

He explained that before 2005 it was possible to interpret the law in that way. However the rewrite of the law in the Income Tax (Trading and Other Income) Act 2005 “made that view impossible to sustain”.

What I find interesting is –

1. I, and everyone else I know, including HMRC, did not find that view impossible at all, at least up to 2009. Indeed s 383(2), ITTOIA 2005 says, “For income tax purposes [dividends from a UK resident company] are to be treated as income …it does not matter that those dividends are capital apart from that section”. I don’t myself think it “unsustainable” that that means that dividends of a UK company are not capital for tax purposes.

2. A Rewrite Act, such as ITTOIA is not permitted to change the law except in minor respects. If it is found that it has done so, HMRC normally tell Ministers who change the law back without any fuss in the next Finance Act.

What seems to have happened here was that in 2005 the Companies Acts did not permit a reduction of capital, or at least made it difficult and expensive to do so. They now do so and these are becoming fairly popular. The result is that a UK subsidiary company can redeem the shares held by its parent with the proceeds being deemed to be a dividend and, as such, being franked investment income of the parent company, which is exempt from corporation tax. Someone in HMRC seems not to have disliked this and HMRC have been contending that where a company does not have sufficient distributable reserves the distribution is capital and as such attracts corporation tax on capital gains.

In other words the problem does not seem to be that the rewrite changed people’s understanding of the law. What seems to have happened is that in pursuance of its off-stated policy of seeking to collect “the right tax at the right time” HMRC decided to mount an argument that the right tax cannot be the amount that the law says, because that would mean that no tax is due. In other words the right amount in HMRC parlance seems to mean not what parliament has determined, but rather as much as possible.

Accordingly the proposed change in the law seems to be a face-saving device. It would be embarrassing for HMRC to have to admit that they tried to get away with collecting tax that was not due, but the same result can be achieved by changing the law retrospectively so that the tax that was not due, but that they tried to collect, again becomes not due. As section 383 seems pretty clear to me I look forward with interest to seeing what change to the wording the government have in mind.



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