Tax Focus podcast: Income or capital? HMRC's consultation on modernising the distributions framework
Latest episode: HMRC's consultation on modernising the distributions framework (Part 1: The big picture)
In the first in a series of podcasts, Maddy Gowlett and Hannah Manning discuss HMRC's wide-ranging consultation on the taxation of distributions and returns of capital from companies to individual shareholders.
Future editions of the series will be released in due course.
On 23 June 2026, HMRC published a consultation titled Modernising the taxation of distributions and repayments of capital from companies.
The consultation proposes fundamental reform to the rules governing how payments from companies to their shareholders are taxed, with a focus on individual shareholders and trusts. It has the potential to be one of the more consequential consultations on UK tax law in decades.
The tax rules surrounding distributions have remained largely unchanged since Corporation Tax was introduced in 1965. HMRC's stated concern is that the current framework allows economically similar payments to shareholders to be taxed inconsistently — in particular, that well-advised shareholders can use restructuring techniques to extract value from continuing businesses at capital gains tax rates rather than dividend rates of income tax.
HMRC also identify distortions arising from the different treatment of distributions from UK and non-UK resident companies, and gaps in the taxation of loans from overseas entities. The consultation frames the proposals as an exercise in modernisation and consistency, addressing (what HMRC consider to be) unintended consequences arising from the operation of the rules and its reliance on anti-avoidance rules to counteract them.
The consultation addresses seven related areas:
Proposed changes include removing the UK residence requirement, extending the relief to investment companies, replacing the 'substantially all' test with an 'all' test (for clarity), and introducing fixed time-based restrictions (generally five years) in place of the current open-ended anti-avoidance conditions.
Currently, only dividends that are not of a capital nature are charged to income tax when paid by non-UK companies. The proposal would extend the charge to cover the full range of distribution types (as defined in the legislation). HMRC are also seeking views on how to address differences between UK definition of 'distribution' and non-UK corporate law concepts.
Options include legislating the current discretionary practice of unwinding inadvertent distributions and allowing income tax paid on an unlawful distribution to be set off against liabilities arising when the position is rectified.
A non-UK resident company is outside the scope UK tax so any tax charge would fall on the individual borrower. The consultation presents four options for implementing the charge, ranging from a charge arising at the end of the tax year to a deemed release after a set period.
These include a minimum 5% shareholding and two-year working requirement, full exit from the company within two years, a five-year claw-back period, and extended holding periods where family connections remain.
The aim is to create a backstop that is clearer and does not depend on HMRC counteraction or proof of motive, while not affecting legitimate commercial restructurings.
The proposals, if enacted in their current form, could affect a broad range of commercial activity including:
Although the consultation states that it is focused on individual shareholders, and is not intended to affect corporate shareholders directly, the proposed definitional changes apply generally and so will inevitably have a corporate impact. HMRC have asked respondents to highlight any Corporation Tax consequences.
This is an early-stage consultation, examining policy options and proposals. HMRC have not yet committed themselves to a particular program of reform. It is encouraging that HMRC have confirmed that they will only move forward after consultation and understanding the commercial impact of its proposals. The consultation document repeatedly invites examples of legitimate transactions that could be adversely affected and suggestions for mitigations.
This consultation is, then, an opportunity to shape future tax policy in a critically important area. The breadth of the proposals — spanning seven chapters, each of which could warrant a consultation of its own — means that practical, real-world examples from businesses and their advisers will be essential in helping HMRC distinguish between the planning they wish to curtail, the unintended consequences they want to correct, and the commercial activity it does not intend to hinder or disrupt.
The consultation runs for 12 weeks, closing on 14 September 2026.
We advise businesses across the full range of corporate transactions that stand to be affected by these proposals — including M&A, demergers, IPOs, private equity investments, and management incentive arrangements.
Our tax policy practice can assist in presenting the interests of your business during the consultation process, whether directly or through our membership of several influential representative and professional bodies. If you would like to discuss how the proposals may affect your business, or if you would like help preparing a consultation response, please contact a member of our tax team.
