Proposal For Significant Reform of the UK Taxation of Individual Shareholders on Proceeds Received From Non-UK Resident Companies

Following on from an announcement earlier this month concerning the taxation of interests held by UK individuals in non-UK reverse hybrid entities such as US LLCs, HM Revenue & Customs have now launched a separate consultation on what could be significant changes to the taxation of shareholder proceeds received by UK resident individuals from non-UK resident companies.

The proposal could potentially have a particularly significant impact on the UK taxation of individual investors in non-UK domiciled investment funds. The corporation tax position would not be affected, nor would the position of non-UK persons.

• Under current UK law the rules for the UK taxation of individuals receiving shareholder proceeds from UK resident companies differ from those for proceeds received from non-UK resident companies.
  
  
• The UK tax system can categorise shareholder proceeds from a UK resident company paid in any legal form (whether a dividend, or whether capital proceeds on shares being repurchased or redeemed) as income distributions for UK tax purposes under the "distribution rules."
  
  
• However, for individual UK resident taxpayers, shareholder proceeds from non-UK resident companies are generally taxed more simply according to the legal form, under the local company law, of the transaction giving rise to those proceeds (as categorised under UK tax laws).
  
  
• In some circumstances, through the structuring of the payment of shareholder proceeds as share repurchase or redemption proceeds (or other capital transactions under non-UK company law), this allows UK individuals to be taxed on non-UK resident company shareholder proceeds as capital proceeds, with generally preferable tax outcomes under current UK tax rates when compared to a simple dividend payment. (There are however anti-avoidance rules which may affect that outcome - including the "Offshore Funds" and "Transactions in Securities" rules.)
  
  
• It is now proposed to create greater alignment between the treatment for UK resident individuals of shareholder proceeds from UK and non-UK resident companies, by expanding the application of at least some of the existing distribution rules to apply to proceeds received from non-UK resident companies as well as from UK resident ones.
  
  
• Although the details of any potential reform remain very uncertain, this would be likely to cause significant complexity, as the distribution rules depend to a large extent on identifying the original amounts subscribed as capital on initial issuance of equity, with only that amount being capable of being subsequently returned on that equity in capital form for UK tax purposes. For many UK shareholders in non-UK resident companies, identifying and quantifying something corresponding to this paid in capital would be at best challenging, and in many cases impossible, due to the combination of the technical difficulty of applying UK tax law principles to a non-UK company law entity, and/or also the evidential difficulties of obtaining the required information from non-UK companies and establishing the position on historic subscriptions for which there would, at the relevant time, have been no reason to maintain records to support a UK tax analysis.
  
  
• A broad implementation of the proposed reform could have a very significant impact on UK individual investors, particularly as relates to the taxation of interests in non-UK investment fund structures involving corporate fund or holding entities. Currently, equity redemption and repurchase transactions are regularly used to structure returns from corporate entities as capital for UK individual investors. Indeed, the use of that structure is arguably endorsed by the existence of the "reporting fund" regime within the UK's "offshore funds" rules. If an element of such proceeds were, in the future, to be categorised as income for UK tax purposes under the distribution rules, even where the underlying source of the proceeds is capital investment gain rather than income, that would result in the UK taxation of an individual investor diverging from the economic reality, and be a deterrent to investment activity.
  
  
• Similarly, the proposed rule change would be likely to be relevant for UK individual investors in a fully UK tax transparent fund structure where a directly held non-UK portfolio company returned capital to investors by way of redemption or share repurchase. To be clear, in transparent structures, the UK tax treatment for individual investors of a simple disposal of a portfolio company's equity held directly under the fund would not be affected.

• There is no proposed target implementation date for the reform, with the consultation process open until 14^th September. The potentially adverse impact on the investment fund industry will no doubt be raised in the process, and it is to be hoped that a workable solution can be found (perhaps, to target more narrowly any perceived gaps within the existing rules). Fried Frank will participate in the consultation process, and we would be pleased to hear of client comment and concerns to ensure we provide comprehensive views on the issue.

• The full consultation, which also involves other aspects of the UK's taxation of corporate distributions, can be found here.

This communication is for general information only. It is not intended, nor should it be relied upon, as legal advice. In some jurisdictions, this may be considered attorney advertising. Please refer to the firm's data policy page for further information.