Foreign law matters when a non-UK resident company purchases its own shares

In UK law a company can purchase its own shares from its shareholders. The question then arises about how this should be taxed.

The issue

The default position is that any proceeds received on a company purchase of own shares (CPOS) over the subscription price will be taxed as a distribution (and subject to income tax at rates of up to 39.35%). However, in special cases, the CPOS can be treated as a capital disposal.

There are various conditions required here but the main ones are that:

• the shares need to have been held for at least five years,
• the shares are in an unquoted trading company, and
• the shares are being acquired wholly or mainly for the purpose of benefitting the company’s trade.

There are also rules that require the shareholders to be significantly reducing their shareholdings.

Non-resident companies

Although it would be easy to conclude that all CPOSs should be subject to income tax if they do not meet the special conditions, this is not the case. The general distribution rules only apply to UK resident companies and the tax position with non-UK resident companies is dictated by separate legislation. In particular, section 402(4) of ITTOIA 2005 excludes dividends of a capital nature from the charge to income tax.

This rule was inserted to factor in the case of Rae v Lazard where it was found that the question of whether a dividend is income or capital in nature is determined by reference to the mechanism of distribution under the law of the territory where the company is incorporated or registered and its implications for the company making the distribution.

Broadly, HMRC considers whether the "corpus of the asset" is left intact after the distribution. If it is not, then the receipt will be a capital receipt; if it is, then it will be subject to income tax.

In Rae v Lazard – which concerned a company incorporated in the US state of Maryland – it was accepted that the corpus would be disturbed by some form of capital reduction, such as the partial liquidation mechanism which exists under Maryland law.

Therefore, where a non-resident company undertakes a CPOS, this is a rare example of a transaction which requires the UK taxpayer to consider the law of the overseas company.

Luxembourg company example

A CPOS by a Luxembourg company is usually treated as capital rather than income based on rules in Luxembourg. However, even this is open to doubt because a recent case determined that amounts issued over and above the market value of the shares could be treated as income if the only reason that they were made was due to the relationship of the shareholder to the company.

This case involved a company with various different alphabet shares. Sometimes, this means the issues may be quite complex when we are dealing with a CPOS by a non-resident company.

In an enquiry, HMRC would be likely to have regard to any local case law relevant to the transaction.

Hamilton Rose's view

Care needs to be taken when considering the tax treatment of a non-UK resident company CPOS and dividends in general. It could be expensive to make a blind assumption that such proceeds are subject to income tax.

Although they often will be, it is important to understand how the local legislation works. It would often make sense to provide a disclosure note in the recipient’s tax return where there is any level of ambiguity.